Navigating your investment accounts and optimizing your tax strategy can feel like a complex puzzle. One crucial piece of this puzzle is understanding and managing your "cost basis" – specifically, how your brokerage firm like ETRADE accounts for the shares you sell. By default, ETRADE uses the First-In, First-Out (FIFO) method, but did you know you have other options that could significantly impact your tax bill?
Are you ready to take control of your investment's tax implications?
This comprehensive guide will walk you through the process of understanding, and potentially changing, how E*TRADE handles your tax lots, moving beyond the default FIFO method. Let's unlock the power of strategic tax management together!
Understanding Cost Basis and Tax Lot Identification
Before we dive into the "how-to," let's ensure we're all on the same page about what we're actually changing.
What is Cost Basis?
Simply put, your cost basis is the original value of an asset for tax purposes. This typically includes the purchase price of a security plus any commissions or fees incurred during the acquisition. When you sell an investment, the difference between its selling price and its cost basis determines your capital gain or loss. This gain or loss is then subject to taxation.
The Significance of Tax Lots
When you buy shares of the same security at different times and different prices, each purchase creates a separate "tax lot." For example, if you buy 100 shares of Company X at $50 in January and another 100 shares of Company X at $60 in March, you now have two distinct tax lots. When you decide to sell 100 shares of Company X, the IRS requires you to identify which specific tax lot those shares came from to accurately calculate your gain or loss.
Default: First-In, First-Out (FIFO)
E*TRADE, like most brokerage firms, defaults to the First-In, First-Out (FIFO) method. This means that when you sell shares, the system automatically assumes you are selling the shares you acquired earliest.
Pros of FIFO: It's straightforward and easy to understand.
Cons of FIFO: In a rising market, selling your oldest, likely lower-cost shares first can lead to higher capital gains and, consequently, a larger tax liability. This might not always be the most tax-efficient strategy.
Beyond FIFO: Exploring Other Tax Lot Methods
The good news is that FIFO isn't your only option! The IRS allows other methods, and E*TRADE provides tools for you to manage this. The most common and powerful alternative is Specific Identification (SI).
Specific Identification (SI)
The Specific Identification (SI) method allows you to choose exactly which tax lots you are selling. This provides immense flexibility and can be a powerful tool for tax planning.
Pros of SI:
Tax Loss Harvesting: You can intentionally sell shares that have a loss to offset capital gains from other investments, potentially reducing your overall tax bill.
Minimizing Gains: If you have multiple lots, you can choose to sell shares with a higher cost basis to minimize your capital gains, or even realize a loss.
Strategic Planning: You can align your sales with your long-term tax goals. For example, selling short-term losses to offset short-term gains, or long-term losses to offset long-term gains.
Cons of SI:
Requires more active management and record-keeping.
You must specify the lot at the time of the sale or very soon thereafter (typically before settlement). You cannot decide this later, during tax preparation.
Other Less Common Methods (May Vary by Brokerage)
While Specific Identification is the most widely used alternative, some platforms might offer variations like:
Last-In, First-Out (LIFO): The most recently purchased shares are sold first.
Highest Cost First-Out (HIFO): Shares with the highest cost basis are sold first, aiming to minimize gains or maximize losses.
Lowest Cost First-Out (LOFO): Shares with the lowest cost basis are sold first, which could be beneficial if you want to realize higher gains for a specific reason (e.g., offsetting other losses).
MinTax (MT - Minimum Tax Impact): A method that prioritizes tax lots to maximize losses and minimize gains.
Step-by-Step Guide: How to Change Your Tax Lot Identification Method on E*TRADE
Changing your default tax lot method on E*TRADE, or making specific lot selections for a trade, is a critical step in optimizing your investment strategy for tax purposes. Here's how to do it:
Step 1: Assess Your Needs and Understand the Impact
Before you click anything, take a deep breath and think. This isn't a decision to be made lightly, as it has direct implications for your taxes.
Engage with your financial goals: Are you trying to minimize taxes this year? Are you looking to realize losses for tax loss harvesting? Or are you simply interested in having more control?
Review your current portfolio: Look at your existing holdings. Do you have multiple lots of the same security purchased at different prices? This is where tax lot identification truly matters.
Consult a tax professional: Seriously, this is highly recommended. A qualified tax advisor can help you understand the nuances of capital gains and losses, the wash-sale rule, and which method is most beneficial for your specific financial situation. They can help you project the impact of different choices on your tax liability.
Step 2: Log In to Your E*TRADE Account
This might seem obvious, but it's the first tangible step.
Go to the official E*TRADE website (us.etrade.com).
Enter your User ID and Password to log in securely.
Step 3: Navigate to Cost Basis and Tax Lot Settings
The exact path might vary slightly with E*TRADE's interface updates, but generally, you'll find these settings within your account management or tax-related sections.
Sub-Step 3.1: Locate "Accounts" or "Portfolio"
Once logged in, look for a menu option like "Accounts," "Portfolio," or "My Accounts." This is usually at the top or side navigation bar.
Sub-Step 3.2: Find "Cost Basis" or "Tax Information"
Within the "Accounts" or "Portfolio" section, search for links or tabs related to "Cost Basis," "Tax Information," "Gains & Losses," or "Statements & Tax Forms."
Sub-Step 3.3: Access Lot Selection Preferences (for default method)
You'll likely find a section titled "Lot Selection" or "Default Lot Selection Method" under "Account Preferences" or "Settings." This is where you can change the default method for future sales.
If you wish to change your default method for all future sales: Select "Specific Identification" (or another desired method if offered beyond FIFO) and save your changes. Remember, this only applies to trades going forward.
Step 4: Making Specific Lot Selections for a Trade (Crucial for SI)
This is where the power of Specific Identification truly comes into play. You'll typically do this at the time you place a sell order.
Sub-Step 4.1: Initiate a Sell Order
Go to the "Trade" section and select the option to "Sell" a security.
Enter the symbol of the security you wish to sell and the quantity.
Sub-Step 4.2: Access Advanced/Tax Lot Options
Before finalizing the order, look for an option like "Advanced Options," "Tax Lot Selection," "Choose Lots," or a similar link near the order preview. Click on this.
Sub-Step 4.3: Select Specific Lots
A window or section will appear displaying all your available tax lots for that specific security. You'll see details like:
Purchase Date: When you bought those shares.
Purchase Price (Cost Basis): The price you paid per share for that specific lot.
Quantity: How many shares are in that particular lot.
Holding Period: Whether it's a short-term (held for one year or less) or long-term (held for more than one year) gain/loss, which impacts tax rates.
Carefully select the specific lots you wish to sell by entering the quantity from each lot. Ensure the total quantity you select matches the quantity you entered for your sell order.
For example: If you want to realize a loss, you would select shares from a lot with a purchase price higher than the current market price. If you want to minimize current gains, you might select shares from a lot that has a higher cost basis (closer to the current selling price) or even a slight loss.
Sub-Step 4.4: Review and Confirm
Always review your selections carefully before proceeding. Ensure you've picked the correct lots and that the resulting estimated gain/loss aligns with your tax strategy.
Confirm the trade. E*TRADE should provide a written confirmation that includes the specific tax lots identified for the sale. This is important for IRS compliance.
Step 5: Record Keeping and Ongoing Management
Changing tax lots isn't a one-and-done deal.
Sub-Step 5.1: Maintain Detailed Records
Keep records of all your transactions, especially when you make specific lot selections. This includes trade confirmations and any communication with E*TRADE regarding lot identification.
While E*TRADE tracks this information, having your own records provides an extra layer of security and helps you with tax planning.
Sub-Step 5.2: Regularly Review Your Tax Lot Strategy
Market conditions change, and so do your financial goals. What was tax-efficient last year might not be this year.
Periodically review your default tax lot method and consider if specific identification for certain trades makes sense, especially around year-end for tax loss harvesting opportunities.
10 Related FAQ Questions
How to access my cost basis information on E*TRADE?
You can typically find your cost basis information by logging into your E*TRADE account, navigating to the "Accounts" or "Portfolio" section, and then looking for "Cost Basis" or "Gains & Losses."
How to ensure E*TRADE reports my chosen tax lots to the IRS?
E*TRADE is legally required to report your chosen tax lots to the IRS on Form 1099-B, provided you make the specific lot selection at the time of sale (or within the settlement period) and receive written confirmation.
How to use Specific Identification for tax loss harvesting on E*TRADE?
To use Specific Identification for tax loss harvesting, identify investments in your portfolio that are currently trading below your purchase price. When you place a sell order for these securities, use the "Tax Lot Selection" option to specifically choose the lots with losses to offset capital gains.
How to avoid a "wash sale" when changing tax lots on E*TRADE?
The wash-sale rule prohibits you from claiming a loss on a security if you repurchase the same or a "substantially identical" security within 30 days before or after the sale. Be mindful of this rule when selling for a loss and considering reinvestment.
How to change the default FIFO method on E*TRADE for all future trades?
You can change your default tax lot method (from FIFO to Specific Identification, for example) in your E*TRADE account preferences, usually under a "Lot Selection" or "Cost Basis" setting. This change will apply to all future sales where you don't manually select specific lots.
How to know if a gain or loss is short-term or long-term on E*TRADE?
When viewing your tax lots on E*TRADE, the platform will typically indicate the holding period (purchase date), allowing you to determine if a potential gain or loss will be short-term (held one year or less) or long-term (held more than one year). This impacts your tax rate.
How to select the "highest cost" tax lots on E*TRADE to minimize gains?
When placing a sell order and accessing the "Tax Lot Selection" option, you will see the cost basis for each lot. You can manually choose the lots with the highest per-share cost to reduce your recognized capital gain.
How to get confirmation of specific lot sales from E*TRADE?
After executing a trade with specific lot instructions, E*TRADE will typically send you a trade confirmation that details which specific tax lots were sold, including their purchase dates and cost bases. These confirmations are crucial for your records.
How to undo a tax lot selection if I made a mistake on E*TRADE?
Generally, once a trade has settled (typically T+2 business days), you cannot change the tax lot selection. It's crucial to review your selections carefully before confirming the trade. If you realize a mistake immediately after placing the order, contact E*TRADE's trade desk as soon as possible, but there's no guarantee they can intervene after execution.
How to learn more about tax-efficient investing strategies with E*TRADE?
E*TRADE offers a "Knowledge" or "Education" section on its website with articles and resources on various investing topics, including cost basis, capital gains, and tax-loss harvesting. You can also contact their customer support for general information, but always consult a qualified tax advisor for personalized advice.
