As more and more retail investors pile into the so-called “democratization of investing” bus that’s supposed to take them to a destination of financial freedom, we continue to see the occasional traps that the oversimplification of investing can bring with it.
Many avid users of the heavily criticized Robinhood app and industry counterparts like Sofi, Webull and others have unfortunately come to this realization when faced with the reality of taxes after realizing what they owe.
Specific Lots Identification
To be fair, most investors have probably never given any thought to exactly what shares they’re selling when it’s time to cut ties or take profits. The benefits of understanding this and utilizing it to your advantage will be noticeable on your tax bill though, and that’s what specific lots identification is for.
Example: You purchased 100 shares of $ABC on March 1st for $100 each, and purchased 100 more shares on April 1st for $150 each. Let’s say on May 1st you wish to start taking profits on $ABC stock because the share price has risen to $200. If you specifically sold the shares you’d purchased at $100, you’ve just accrued $10,000 in short-term capital gains. Consider though if you had sold the shares purchased at $150 instead. In this case, you only have $5,000 in realized short-term cap gains.
Either way, you are selling 100 shares of a $200 stock and adding $20,000 in buying power to your account. The only difference is in the taxable gain, which is based on the cost basis of the stock you sold.
This should paint a pretty clear picture of how this can be advantageous when it comes to tax time, and it’s especially valuable to investors who don’t want to fully liquidate their position. Which shares are sold, and which ones are held, matter.
Trading apps don’t have this functionality yet
Robinhood, Webull, and many other retail trading platforms do not allow their users this level of tax lot selectivity when selling their shares right now. Most of them use what’s known as the FIFO (first in first out) method versus the LIFO (last in first out), which means the shares you’ve owned the longest automatically get sold first when you place an order to sell stock that's less than your full position.
This is specifically bad for stocks that have increased in value over time since the earliest shares you bought are likely the cheapest, leaving you with essentially the biggest capital gain bill possible every time.
So... what do you do?
The option to choose which share lots you want to sell will likely become available on these popular trading platforms eventually, but for now, you’ll need to circumvent it and create your own solution.
Having multiple brokerage accounts, especially with one that allows you to choose your tax lot could be a smart move. Think Fidelity, Schwab, TD Ameritrade, E*TRADE, etc.
📚 Beware of the wash-sale rule when making these trades too. Take our 6-minute learning quiz to learn more about it: