LIFO tax basis method
The LIFO method (Last In, First Out) is a cost basis approach where the newest tax lot is sold first. LIFO can be more tax-efficient than FIFO when recent purchases are at higher prices, allowing you to realise smaller gains. It is most useful during volatile or rising markets, though it requires explicit election and careful documentation.
For alternatives, see specific identification, FIFO, and average cost. For the framework, see cost basis.
How LIFO works
Suppose you own 200 shares acquired in two lots:
- Lot 1 (January 2010): 100 shares at $50 = $5,000 cost
- Lot 2 (January 2024): 100 shares at $150 = $15,000 cost
Current price: $200 per share. You want to sell 100 shares.
Under LIFO, you sell Lot 2 first (the newest). Your gain is $200 - $150 = $50 per share × 100 = $5,000 gain.
Under FIFO, you would sell Lot 1, generating a gain of $150 × 100 = $15,000. LIFO saves you $10,000 in taxable income—a significant advantage.
When LIFO shines
LIFO is most beneficial in three scenarios:
Rising markets. When prices generally trend upward, newer lots are at higher prices. Selling them first generates smaller gains.
Dollar-cost averaging. If you steadily buy into a position over years, older lots will be at lower prices; selling newer lots (at higher prices) minimises gains.
Market corrections. In a downturn, if you hold lots purchased at all different prices, LIFO lets you use recent losses to offset old gains. When a stock rallies after a crash, you can sell recent lots at near-recovery prices while preserving old, low-cost lots.
When LIFO is poor
Falling markets. If newer lots are at lower prices than old lots (because you bought at the peak), LIFO forces you to sell losers or breakeven positions, realising the smallest gains but not harvesting the largest losses.
Stable or declining holdings. If you own a stock that has fallen or flatlined and you bought at various prices, LIFO offers no advantage.
Election and requirements
LIFO is not automatic. You must affirmatively elect it with your broker, usually via written request. Once elected, it applies to all transactions in that security within that account for that tax year and future years. Switching methods or accounts requires IRS Form 3115 (Application for Change in Accounting Method), which can be burdensome.
Important caveat: LIFO is not available for mutual funds. It is used mainly for individual stocks and some commodities. Check with your broker if you are unsure whether LIFO is available for your holding.
Comparison to FIFO and specific identification
| Method | Simplicity | Flexibility | Tax Efficiency |
|---|---|---|---|
| FIFO | High | None (default) | Often poor |
| Specific identification | Medium | Excellent | Excellent |
| LIFO | High | Medium | Often good |
| Average cost | Very high | None | Moderate |
LIFO is a good middle ground: it is automatic once elected, offering more flexibility than FIFO without requiring a written instruction at each sale. However, specific identification offers the greatest tax efficiency if you are willing to manage it.
Accounting and inventory
LIFO is an inventory accounting method borrowed from inventory valuation. In inflationary periods, LIFO can provide real tax savings for businesses. For individual securities, the benefit is more limited but still meaningful.
See also
Closely related
- Cost basis — the framework for all methods
- FIFO tax — opposite method (oldest first)
- Specific identification — most flexible method
- Average cost basis — averaging method
- Tax lot — individual purchases
Wider context
- Capital gains tax for investors — the gain from LIFO selection
- Form 8949 — reporting basis
- Wash-sale — may interact with lot selection
- Long-term capital gain tax — rate applied to LIFO gains