What does LIFO or FIFO for stocks mean? And what implications do these acronyms have on your ability to buy and sell stocks? It is always a good idea to have answers to such questions if you are interested in investing regularly within the stock market.
LIFO or FIFO for Stocks: Meaning
In stock market terms, LIFO stands for last-in first-out. In such a situation, if you want to sell some shares of a particular stock, those shares that you bought most recently will be sold first. And then, those shares you bought earliest will be sold last.
On the other hand, FIFO stands for first-in first-out. When using this kind of investment strategy, those shares you bought earliest will need to be sold first. And then, the most recently bought shares will be sold last. Generally, many stock brokerages will resort to using FIFO when doing tax reporting, and the IRS considers it the default selling strategy.
But since there are implications for both stock selling strategies, it would be wise of you to specify how your shares should be treated when ordering a stock sale.
Read More: The Difference Between Stakes, Shares and Stocks
LIFO or FIFO for Stocks: Tax Implications
Most stock market moves that occur outside a retirement account usually have tax implications. And both LIFO and FIFO selling strategies will impact the way you pay taxes. However, their implications will differ.
Long-Term and Short-Term Gains
If you sell a stock after holding it for more than a year, you will pay long-term gains taxes. But if you sell some of your stock after holding it for less than a year, you will likely pay taxes at the ordinary rates.
Generally, long-term gains are taxed at zero or 15 percent for individual taxpayers earning $445,850 or less. And you will pay 20 percent for anything over that.
But if you sell your stock after holding it for less than a year, you will be taxed at ordinary rates. And an income of $445,850 would attract an ordinary tax rate of 35 percent for both the tax year 2021 and the year 2022.
Therefore, using a LIFO strategy could cost you if you held some shares of a particular stock for less than a year and got rid of them. The IRS may apply a short-term capital gains tax rate. However, a FIFO strategy could enable you to pay a long-term capital gains tax, which would be lower.
Capital Gains Appreciation
How much you make overall while investing in a particular stock matters. Generally, the longer you hold a stock, the higher its capital appreciation will be. That means over time, its increase in value will be pretty significant.
When you use FIFO, the earliest shares will have the lowest cost basis. The term refers to the original value at which you acquire the stock. And that means your capital appreciation over time will be higher. So your taxable income from selling stocks will also be higher.
On the other hand, if you use LIFO, you can increase your cost basis and reduce your capital appreciation. As a result, you can cut down your taxable gains from selling stock.
Looking at an Example
Suppose on May 15, 1997, Amazon’s original share price during the IPO was $18 a share. Had you spent $1,000 then to buy 55 shares, according to Statista, your investment today would be worth $2,340,653 or so by July 2021. That is an astounding capital appreciation.
Had you sold your shares for that amount, you would have made a capital gain of $2,339,653, assuming your cost basis is $1,000. And that would be what is taxed at long-term capital gains rates. However, if you had bought the same number of shares at $89,680 in 2010, your capital gains by 2021 would be $2,250,973.
So, if you bought additional shares later on at a higher price, you could ask your broker to sell those first, to offset some of your capital appreciation to reduce your taxable gains.
Final Thoughts on Strategies
It is important that you understand how LIFO and FIFO selling strategies can impact your capital appreciation and the tax implications they can cause. That way, you can minimize your tax liabilities and keep more money in your pocket.
Generally, FIFO works well when you have both short-term and long-term gains and need to take advantage of long-term tax rates. However, LIFO may be the best option when your average buy-and-hold period is usually more than a year and you need to reduce capital appreciation.
Read More: Pros & Cons of Buying Short Sales
- US News: Difference between LIFO/FIFO can mean lower tax
- IRS.Gov: Topic No. 409 Capital Gains and Losses
- IRS.Gov: IRS provides tax inflation adjustments for tax year 2021
- IRS.Gov: IRS provides tax inflation adjustments for tax year 2022
- The Business Professor: Capital Appreciation - Explained
- Statista: If You Had Invested In Amazon's IPO...
- First in, first out (FIFO) means that the first shares of stock to be sold are the first shares acquired. If the stock's value has constantly increased, these will be the shares of stock with the lowest basis, and then the most gain or lowest amount of loss.
- Conversely, last in, first out (LIFO) means that the first shares of stock to be sold are the last shares acquired. If the stock's value has constantly increased, these will be the shares of stock with the highest basis, and then the least gain or greatest amount of loss.
- Basis is typically the investor's cost of the stock, although it may differ when the shares of stock were inherited.
- The IRS does not formally recognize the last in, first out (LIFO) methodology. Instead, it recognizes the "specific identification" methodology. When the specific identification methodology is used to indicate the last shares acquired, it is equivalent to the LIFO methodology.
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