What Is Specific Share Identification?

Specific share identification is an accounting method available to investors for managing the tax implications of selling securities. When an investor acquires shares of the same stock or fund at different times and for different prices, they create distinct “lots” of shares, each with its own cost basis. This method allows the investor to choose precisely which of these lots to sell. The primary function of this approach is to control the amount of capital gain or loss realized from a sale.

By selecting specific shares, an investor can strategically influence their tax liability for the year. For instance, selling shares that were purchased at a higher price will result in a smaller capital gain or a larger capital loss, potentially lowering the investor’s tax bill. This contrasts with default methods where the choice of which shares are sold is automatic.

This method requires careful planning and communication. It is not a retroactive decision that can be made when preparing taxes; the choice must be declared at the time of the sale. The flexibility offered by specific share identification comes with the responsibility of meticulous record-keeping to substantiate the transactions.

Understanding Cost Basis Methods

To appreciate the utility of specific share identification, it is helpful to understand the other primary methods for determining the cost basis of securities sold. The default method, which the Internal Revenue Service (IRS) mandates for brokers if no other instruction is given, is First-In, First-Out (FIFO). Under FIFO, it is assumed that the first shares an investor purchased are the first ones they sell. This method is straightforward but can lead to significant tax consequences, especially in a rising market where the oldest shares have the lowest cost basis and thus generate the largest capital gains.

For example, if an investor bought 100 shares of a company at $50 and another 100 shares a year later at $75, a sale of 100 shares under FIFO would use the $50 purchase price to calculate the gain. This simplicity is its main advantage, but it offers no flexibility for tax management. Brokerage firms automatically apply the FIFO method for stocks unless the investor specifies a different approach for a particular sale.

A different approach, the Average Cost method, is also permitted by the IRS, but its use is restricted to mutual fund shares and those acquired through dividend reinvestment plans (DRIPs). This method calculates the cost basis by averaging the purchase price of all shares owned in the fund. While this method can smooth out the tax impact, it also removes the investor’s ability to select specific, higher-cost shares to minimize a taxable gain.

Requirements for Adequate Identification

To successfully use the specific share identification method, the IRS imposes strict requirements for what it considers “adequate identification.” The core of this requirement is the taxpayer’s ability to definitively prove which specific shares were sold. This proof must clearly identify the securities by their purchase date, the quantity of shares sold from that specific lot, and the original cost basis. Without this level of detail, the IRS will default to the FIFO method for the transaction.

For the vast majority of investors whose shares are held in a brokerage account, the responsibility lies in providing clear instructions to the broker. The investor must direct the broker to sell a specific lot of shares at the time the sell order is placed. This instruction must be unambiguous, specifying details such as the acquisition date and cost of the shares being sold.

The Process of Selling Specific Shares

Executing a sale using the specific share identification method is a procedural process that begins after you have identified the exact lot of shares you wish to sell. The important step is to formally communicate this instruction to your broker. This directive must be given contemporaneously with the trade, meaning at the time you place the sell order, not days later or when you are preparing your taxes. Most modern brokerage platforms provide a mechanism to select specific lots directly on their online trading interface when entering a sell order.

If the online platform does not offer this feature, or if you prefer a different method, you can provide instructions through other channels. A written letter or a recorded phone call to the broker explicitly stating the purchase date and cost of the shares to be sold are also acceptable methods. The instruction must be clear, specific, and provided to the broker before the settlement date of the trade. The standard settlement cycle for most stock trades in the U.S. is one business day, which means that instructions must be provided promptly.

After providing the instruction, you must obtain a written confirmation from the broker acknowledging your specific share selection. This confirmation is your primary evidence to the IRS that you adequately identified the shares at the time of the sale. The confirmation should reiterate the details of your instruction, verifying which lot was sold.

Without this written confirmation, the IRS could disregard your use of the specific identification method and re-calculate your capital gain using the default FIFO method, which could result in a higher tax liability. You should follow up to ensure you receive and retain this formal acknowledgment from your brokerage firm.

Recordkeeping and Tax Reporting

When it comes time to file your taxes, the sale must be reported on Form 8949, Sales and Other Dispositions of Capital Assets. This form is used to detail each individual capital asset sale. You will list the details of the transaction, including the description of the property (the stock), the date acquired, the date sold, the sales price, and the cost basis. The totals from Form 8949 are then carried over to Schedule D, Capital Gains and Losses, which is filed with your Form 1040.

A frequent point of confusion arises with Form 1099-B, which you receive from your broker. The cost basis reported by the broker on Form 1099-B might be based on the FIFO method, especially if their system defaults to it. If the basis on the 1099-B does not match the basis from your specific identification instruction, you must still report the transaction on Form 8949. You will enter the information from the 1099-B and then make an adjustment in column (g) of Form 8949 to correct the cost basis to reflect your specific identification choice, using the appropriate adjustment code in column (f).