Death & Taxes

Identifying Stock Sold
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By Roy Lewis

It looks like my article on Identifying Stock Sold started a small firestorm... at least if my email is any indication. Some questioned my sanity. Some my ability to walk and chew gum at the same time. Others questioned my heritage (no... my father did not marry a donkey). I just have one thing to say about the entire issue:

It's not my fault!

Well, I actually have a few more things to say.

I don't make or enforce the rules; I just try to explain the rules. You might not like them. Your broker might not like them. And, you both might elect not to follow them at your own peril. But, if you choose not to follow the rules as explained, you're exposing yourself to some potential audit bruises.

A number of people wrote that the IRS no longer requires brokers to confirm identification of the specific shares sold for the taxpayer to use the specific share method. But nobody could provide an Internal Revenue Code section, Regulation, or court case to support that position. Some pointed to the 1994 Concord Industries Corp. Tax Court Memo as authority. It's not the best case in the world and, for a number of technical reasons, not really "authority" in the true sense of the word.

But, we could argue the technical issues for the next three days and get nowhere. So let's take a look at some real-world issues on this matter.

Many folks asked what I do about specific identification. Before I tell you, understand that this issue is really not that important to me. A big trading year for me is perhaps five to ten total trades. I almost never purchase multiple lots in the same stock. And if I do, I always try to do so in one of my tax-deferred retirement accounts because all the specific identification problems become moot in a tax-deferred account.

Here is how I addressed this problem with my e-broker. A number of years ago, I mailed my broker a certified letter telling him that, on any future stock sale in my taxable account, the shares with the highest basis are the shares that are to be sold.

I don't know what the broker did with the letter, since I never received a response, but I have my copy in my files, along with the "return receipt" proving they received it. I make my trades and report the basis of my sales based on this "systematic" method. Once I make a sale, I immediately report the sale against the shares with the greatest cost basis. As you can imagine, my record keeping is impeccable. Does this put me in the clear? Nope... for a number of reasons.

First, this isn't a true specific identification method. I always sell the shares with the highest cost basis first. While this works for me, it might not work for you.

Second, it's not in compliance with the regulations that require written confirmation from the broker. I'm hanging my hat on the fact that I'm using the same system from year to year, and have alerted my broker to that fact. Because of this, I'm taking the "judgment" out of any sales, which I believe allows me to meet the spirit (if not the letter) of the law.

Third, would this method stand up under IRS scrutiny? I don't know. I hope so. I'm willing to take that chance because this issue is of little concern to me. So, what I do really has no impact on what you should do.

But, I will tell you this: If ever in a position where making a specific identification would save me substantial tax dollars, I would make absolutely sure that I received written confirmation -- and if that means moving my account to another broker before executing the sale, that's what I would do. I'm not going to potentially jeopardize substantial tax savings for the lack of a scribbled note on a confirmation slip or a brief letter from the broker. Heck, I'd tell the broker what to write, and would even write it for him.

Sadly, this is where full-service brokers have it all over e-brokers and other discount brokers. Just making this statement in the realm of The Motley Fool might qualify as blasphemy, but it's the truth... at least based on my experience. Neither I nor any of my clients have had a problem receiving an adequate written confirmation from a full-service broker once the issue and importance is explained. Unfortunately, this has not been my experience with Internet or discount brokers. It seems that e-brokers would rather spend 20 minutes explaining why they don't have to provide the confirmation, than the 5 minutes it would take to actually prepare it.

So what does this mean to you? Well, you have a few options.

If at all possible, do your "trading" in multiple lots of the same stock in your tax-deferred account, not your taxable account. That will render the specific identification issues meaningless. It'll also protect you from the wash sale rules.

Do nothing and elect the FIFO method for each sale of multiple purchases. It might cost you some tax dollars, but you'll not have to worry about broker confirmations. It doesn't seem like a very good trade off to me, but you might think otherwise.

Simply ignore the confirmation requirements, and report your sales as you darn well please. Just be willing to suffer the consequences if Uncle Sammy takes a look at your trades (read: audit) and determines that, by not having appropriate written confirmation, you used the FIFO method -- and then hands you a tax bill. I simply don't like to use the "audit lottery" method of tax planning. You might be bolder.

Complete some substantial legal and tax research to arrive at a system that you believe meets the requirements of the regulations for specifying stock sales without the benefit of a broker confirmation. But, again, hope that Uncle Sammy doesn't look at your return and, if he does, hope that he agrees with your system. If not, you might receive a request to pay additional tax dollars.

Find a broker that will provide, on request, a written confirmation with the information you need to specifically identify the shares you sold. It's not that big of a deal. You don't need a confirmation for each and every sale you make, just those dealing with multiple purchases of the same stock.

Don't let some broker mislead you into thinking that written confirmation isn't required. That's just not the case. If this is an important issue to you, then find a broker that will comply with your wishes and your needs.

Then tell all of your friends about that broker. And, have them tell their friends. Word will travel like wildfire and might cause the entire Internet brokerage business to take notice and become more responsive to your investment needs. That could be a very good thing in the long run.

It's your life, your investments, your concern, and your decision. Make the best of it.

This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.