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How are stocks taxed when sold?


Dear Tax Talk,
How are stocks taxed when sold? Is it an average cost per share if the investor "dollar cost averaged" when purchasing? Can I sell 100 shares and take the loss using the lowest price paid per share? -- Merilyn

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Dear Merilyn,
Dollar cost averaging is the process of buying a set dollar amount of stock on a periodic basis. Since the value of stock fluctuates, each purchase results in a different number of acquired shares.

When you sell less than the entire position in a stock, you need to allocate a cost to the shares sold. In the case of stock, this is done either by specific identification or on a first-in, first-out basis.

Specific identification means that you identify particular shares to be sold. If you had the actual shares in your hand, you would do this by delivering those shares to your broker for sale. The cost would be the cost of the lot of shares so delivered.

However, since most stock is held in street name by your broker, specific identification involves instructing your broker to sell shares acquired on a particular date. You should note, though, that if you identify stock held less than a year, your capital gain is short-term, meaning it's taxed at ordinary income rates.

On a first-in, first-out basis, the stock that you first acquired is treated as sold. If the value of the stock is rising, this results in your recognizing more gain or less loss. Depending on your circumstances, either method may be beneficial or detrimental. For example, selling the first shares might result in a long-term gain, whereas specific identification could result in a lesser gain -- but at short-term rates.

Average costing is available only with mutual fund shares. In this case, you would use the average cost of all shares acquired, including dividend reinvestments, through the date of the first sale. You can read more on cost basis of stock starting on page 41 of IRS Publication 550, Investment Income and Expenses.

-- Posted: Nov. 4, 2003




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