FIFO tax basis method

The FIFO method (First In, First Out) is the default way your broker assumes you sell shares if you do not specify otherwise. When you own multiple tax lots at different prices, FIFO sells the oldest lot first. For investors who bought long ago at low prices, FIFO is typically the least tax-efficient method, maximizing gains and tax bills. Choosing specific identification instead can save thousands of dollars.

How FIFO works

Suppose you own 200 shares acquired in two lots:

• Lot 1 (January 2010): 100 shares at $50 = $5,000 cost
• Lot 2 (January 2020): 100 shares at $150 = $15,000 cost

Current price: $200 per share. You want to sell 100 shares.

Under FIFO, you sell Lot 1 first (the oldest). Your gain is $200 - $50 = $150 per share × 100 = $15,000 gain.

If you had used specific identification to sell Lot 2 instead, your gain would be $200 - $150 = $50 per share × 100 = $5,000 gain. That is a difference of $10,000 in taxable income, or roughly $1,500 in federal tax at long-term rates.

Why FIFO is the default

FIFO is the IRS default because it is simple and objective. With FIFO, there is no ambiguity—the oldest lot goes first. The IRS does not need to verify written instructions; the record-keeping is straightforward. This is why most brokers default to FIFO if you do not specify otherwise.

When FIFO is harmful

FIFO is especially harmful for long-term investors who bought decades ago at low prices and are now sitting on massive embedded gains. Every share sold realises the original, low-cost basis, maximising the taxable gain. Over a portfolio’s life, this can cost hundreds of thousands of dollars in unnecessary tax.

When FIFO might be acceptable

If you buy and sell frequently, or if your lots are all recent and similar in price, FIFO is a minor issue. The problem is concentrated among investors with old, low-cost lots and much newer, high-cost lots.

How to avoid FIFO

Use specific identification. Write to your broker at the time of sale, specifying which lot to sell. Most brokers accept email. This is the simplest solution and requires no IRS permission.

Use LIFO. If you prefer an automatic method, elect LIFO (Last In, First Out), selling the newest lot first. This is often better than FIFO if newer lots have higher bases.

Use average cost. For mutual funds, average cost averaging is sometimes pre-elected. It is not optimal, but it is better than FIFO in many cases.

Reporting and compliance

FIFO is assumed if you do not specify. Your broker will report on Form 8949 using the oldest lot cost basis. If you want a different method, you must affirmatively elect it and document it. Keep your written instruction for your records.

See also