Tax-Lot Relief
Tax-lot relief is the umbrella term for the methodology used to determine which specific lots of a security are sold when only some lots are dispositioned. Common methods: First-In-First-Out (FIFO, the default), Last-In-First-Out (LIFO), Highest-Cost-First-Out (HIFO), Average Cost (mutual funds default), and Specific Lot Identification (taxpayer-elected). The choice has direct consequences on realized gain or loss, holding-period mix, and downstream tax cost.
Lot-relief methodology is the lever that turns lot-level inventory into tax-optimized outcomes. A single sell decision can have markedly different tax consequences depending on which method is applied — sometimes by 30–50% of the realized gain. The default FIFO produces the worst outcome on appreciating assets (oldest = lowest basis = largest gain); HIFO inverts this; specific lot ID lets the taxpayer pick exactly. Average cost was the historical mutual-fund default and remains common but loses lot-level granularity entirely.
Election mechanics vary by custodian. Schwab, Fidelity, Vanguard, and IBKR support all major methods; the taxpayer elects via account-management UI. Elections apply to subsequent trades, not retroactively. Some custodians require per-account or per-symbol elections; others apply globally. Mutual funds had a one-time election window in 2012 (when basis-cost reporting became mandatory for new lots) — taxpayers had to choose average-cost or specific-lot for the new covered lots.
The practical default-vs-optimized split is large. A 2024 industry survey found ~62% of retail accounts still on FIFO by inertia. The 'right' default depends on the holding context: appreciating taxable equity benefits from HIFO; depreciating-then-recovering positions benefit from FIFO (preserve loss-harvest opportunities); short-term traders sometimes prefer LIFO to capture short-term losses while preserving long-term gains. Specific lot ID dominates tactical scenarios but requires per-trade attention.
For cryptocurrency, the IRS explicitly permits specific lot identification (Notice 2014-21) but requires contemporaneous identification at trade time — not retroactive selection. Most crypto exchanges support FIFO and LIFO defaults; some support HIFO and specific lot ID. The active retail crypto-trader population is mostly on LIFO or specific lot for the tax-optimization benefits.
| FIFO | HIFO | LIFO | Specific Lot ID | |
|---|---|---|---|---|
| Sell order | Oldest first | Highest-basis first | Newest first | Author's choice |
| Default for equities | Yes | No (election) | No (election) | No (per-trade) |
| Tax on gains (appreciating) | Worst | Best | Often near-best | Optimal |
| Operational complexity | None | Low | Low | High |
| Common context | Retail default | Tax-aware retail | Crypto, ST harvest | Tactical optimization |
Synthetic accounts should track elected lot-relief method per account or per symbol. Sell-engine code must apply the elected method to determine realized gain/loss correctly. Test scenarios should cover all major methods on the same lot inventory to verify the engine's output matches each method's expected outcome.
Common pitfalls
- Applying the default FIFO method without honoring per-account elections — produces wrong tax answers when the holder elected an alternative.
- Treating average-cost mutual-fund positions as having lot granularity — once aggregated to average-cost, lots lose their individual basis identities.
- Using one method for tax computation and another for performance reporting — internal inconsistency leads to reconciliation breaks.
- Forgetting that lot-relief elections lock at trade time — once a sale is executed under one method, can't be retroactively reassigned.
Examples
Position has 3 lots: A (30sh @ $80, 2018, LT); B (40sh @ $140, 2021, LT); C (30sh @ $190, 2024, ST). Current price $200. Sell 50 shares ($10,000 proceeds). FIFO: 30 from A + 20 from B = $4,800 LT gain. HIFO: 30 from C + 20 from B = $700 (mix LT+ST). LIFO: 30 from C + 20 from B = same as HIFO here. Specific lot ID: optionally any combination — e.g., 50 from C alone produces $300 ST gain. Choice of method: $4,800 gain vs $300 gain.