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Identify stock shares for better tax results

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in Small Business Tax

The stock market continues to have its ups and downs. Therefore, it’s not unusual for an investor to own shares of the same stock purchased at different times and different prices. How are tax gains or losses calculated when a few shares are sold?

When in doubt, the IRS assumes the first shares bought are the first ones sold. This is called the first-in, first-out (FIFO) method.

Strategy: Don’t blindly follow the IRS approach. Instead of using FIFO, you can specifically identify shares of securities that you intend to sell. This can produce a better tax result for a particular situation.

By specifically identifying the shares being sold, an investor may even turn a taxable gain into a beneficial tax loss.

Example: Turn the tax rules in your favor 

Say you bought 100 shares of Emerald City Corp. stock on Oct. 1, 2009, when the price was $10 a share, 600 shares on Nov. 1 when the price dropped to $5 a share and 300 shares on Dec. 1 when the price rebounded to $20 a share. Currently, you own 1,000 shares with an average cost of $10 per share.

Now the Emerald City stock is selling at $12 a share. If you sell 100 shares, the IRS will presume that the first shares you bought are the first ones you sold. That gives you a short-term gain of $200. However, if you specifically identify the 100 shares being sold as coming from the block of shares acquired on Dec. 1, you will show a loss of $8 a share. The $800 loss can be used to offset other capital gains realized during the year.

Note that the tax rules provide some leeway. For instance, if the situation dictates it, you can settle for the $200 gain. Alternatively, if you identify the 100 shares being sold as coming from the 600 shares acquired on Nov. 1, the gain would be $700. You might want to opt for a higher taxable gain if you expect 2010 to otherwise be a low-income year. In addition, you might plan ahead for higher tax rates coming in 2011.

How do you identify the shares that you’re selling? At the time of the sale, an investor must specify to the broker or other agent the specific stock to be sold. The stock being sold is identified by the purchase date, the purchase price or both. Make sure that you receive a written or e-mail confirmation.

Tip: If you’re an online trader who does not use a broker, you must maintain detailed records of the shares being sold.

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