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James Chen, CMT is an expert trader, investment adviser, and global market strategist.
Updated October 11, 2021 Reviewed by Reviewed by Lea D. UraduLea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.
Fact checked by Fact checked by Vikki VelasquezVikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.
Specific share identification is an investment accounting strategy in which the investor intends to obtain the most favorable tax treatment when selling holdings within an asset that were purchased at different times and prices.
Specific share identification is an accounting strategy for investors who wish to optimize their tax treatment when selling off their holdings in a particular company or fund which were originally purchased at different prices and different times.
Capital gains taxes are levied on profits made from the sale of assets. An investor who buys a share of stock at $10 and later sells at $20 will show a capital gain of $10, which is taxable. An investor who only makes a single investment in an asset will not benefit from specific share identification, because when they sell that asset, the acquisition price is the same for every share of that asset.
Another investor purchases 10 shares of a stock each year for three consecutive years. Each year the per-share price, also known as the cost basis, increases by $10. In this scenario, the investor purchases 10 shares at $10 per share in year one, for a total investment of $100. In year two, the investor purchases 10 more shares for $20 per share, and 10 shares in year three for $30 per share.
If this investor chooses to sell a portion of these assets the next year for $40 per share, the capital gains will differ slightly for each group of shares, and specific share identification can be a helpful strategy for the investor to optimize their tax treatment on those capital gains.
The IRS provides several strategies for reporting capital gains, and these are delineated each year in Publication 550: Investment Income and Expenses. Investors are advised to consult the latest publication for current regulations on capital gains reporting.
For most funds, First In, First Out (FIFO) is the default option for reporting capital gains on share sales. The assumption is that the first shares an investor purchases are the first sold. In our above scenario, if the investor sells fifteen shares with FIFO in place, they will sell the 10 shares purchased in year one and five shares purchased in year two, showing taxable capital gains of $30 on each of the first-year shares, and gains of $20 on each of the second-year shares.
It is possible for some investors to use the average cost method of accounting, which averages the cost basis for all shares in the portfolio, and taxable gains are calculated on that figure. In our scenario, the average cost basis for the three years’ worth of assets is $20, and so the sale of 15 shares at $40 would result in taxable gains of $20 per share.
As its name suggests, with specific share identification, the investor can choose which shares are sold. For instance, they could sell all of the shares acquired in year three and five shares of those acquired in year two. They could sell five shares of each year's acquisitions or any other arrangement which the investor may think advantageous for their particular investment strategy.
Specific share identification allows for greater flexibility, but it requires meticulous record-keeping. Additionally, investors interested in this strategy are advised to be aware of regulations regarding the ways profits are taxed on assets that are held for shorter terms. In many cases, profits made on an asset held for only a year or less are taxed at a higher rate than assets that have been held in a portfolio for a longer term.
The most basic advantage of employing specific share identification is that it allows investors to minimize gains, maximize losses, or realize long-term rather than short-term gains. All of these events will lower an investor's tax bill. Furthermore, using the specific share identification strategy may enable investors to utilize tax-loss harvesting. Tax-loss harvesting occurs when an investor sells shares at a loss in order to offset a capital gains tax liability.
One downfall of the specific share identification accounting method is that it requires the investor to be incredibly meticulous in their record-keeping. Clearly, using this accounting strategy can produce the most tax-efficient results. However, if you have your brokerage does not provide a good user interface for selling specific shares, you have to personally keep track of tax lots. Not all investors can dedicate that amount of time to their investment strategy.
