ETF Tax Lot Management: Specific ID vs FIFO - How to Save Thousands on Capital Gains

• by Crystal Jedynak
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Why Your ETF Tax Lot Choice Could Save You Thousands

Let’s say you bought 100 shares of an ETF at $50 a share two years ago. Then you bought another 100 shares at $80 last month. Today, the ETF is trading at $100. You want to sell 100 shares. Which ones do you sell? If you don’t pick, your broker will pick for you - and it might cost you hundreds, even thousands, in extra taxes.

That’s where tax lot management comes in. It’s not about picking the best ETF. It’s about picking which shares to sell. And the difference between Specific Identification (Specific ID) and First In, First Out (FIFO) can be the difference between paying $1,350 in taxes or $600.

What Exactly Is a Tax Lot?

Every time you buy shares of an ETF - even the same ETF - you create a new tax lot. Each lot has its own price, date, and holding period. If you bought 50 shares in January 2023 at $45, that’s one lot. You bought 75 more in June 2024 at $72? That’s another lot. Each one is tracked separately by your broker.

When you sell, you have to say which lot you’re selling. The IRS calls this “tax lot identification.” If you don’t choose, your broker defaults to FIFO - meaning they sell the oldest shares first. That might sound fair, but it’s often the worst choice for your wallet.

How FIFO Works (and Why It’s Often a Mistake)

FIFO means the first shares you bought are the first ones sold. In our example, if you bought shares at $50 and $80, FIFO sells the $50 ones. That means a $50 gain per share ($100 sale price - $50 cost). For 100 shares, that’s a $5,000 capital gain.

But here’s the catch: those $50 shares were bought two years ago. That’s a long-term gain - taxed at 15% or 20%, depending on your income. Sounds okay, right? Not if you have newer shares with higher cost bases.

Let’s say you also bought 50 shares at $90 last November. If you’d sold those instead, your gain would be only $10 per share - $500 total. That’s a $4,500 difference in taxable gain. FIFO doesn’t let you pick. It locks you into the lowest cost basis first, maximizing your gain. And if you’ve bought shares during a market dip or a rally, FIFO can accidentally trigger short-term gains you didn’t intend.

How Specific ID Gives You Control

Specific ID lets you pick exactly which shares to sell. You can choose the $90 lot, the $80 lot, or even a mix. You’re not stuck with what the broker picks.

Here’s the power move: if you want to minimize taxes this year, sell the highest-cost shares. That shrinks your gain. If you’re planning to hold long-term, sell the low-cost shares that are already qualified for long-term rates - and leave the newer, higher-cost ones to grow.

Let’s look at a real scenario from Charles Schwab’s research:

• You sell 100 shares at $100 each ($10,000 total).
• FIFO uses your $10/share purchase - $1,000 cost basis → $9,000 gain → $1,350 tax at 15%.
• Specific ID picks your $65/share purchase - $6,500 cost basis → $3,500 gain → $840 tax at 24%.
• Optimized Specific ID (using a tool) picks a mix that gives you $6,000 basis → $4,000 gain → $600 tax at 15%.

That’s $750 saved just by choosing smarter. And that’s one trade. Do this every quarter? You’re talking real money.

When FIFO Actually Makes Sense

It’s not all bad. If you’re not actively managing your portfolio, FIFO is simple. It’s automatic. No decisions needed. And if your oldest shares have a high cost basis - maybe you bought during a crash - FIFO might work fine.

Also, if you’re harvesting losses to offset gains, FIFO can help. Selling the oldest, lowest-basis shares might free up room to use losses without triggering big gains. But that’s a strategy, not an accident. You need to plan it.

Most people don’t plan. They just hit “sell” and assume their broker is helping them. It’s not.

The IRS Rules: You Can’t Change Your Mind After the Fact

Here’s the big trap: you can’t pick Specific ID after the trade settles. The IRS requires you to specify the lot before the trade executes. And your broker must confirm it in writing - email, app notification, or trade ticket.

Green Trader Tax calls this “contemporaneous action.” That means no backdating. No “I meant to pick the $80 lot” after the fact. If you didn’t say it before the trade, FIFO kicks in - and you’re stuck with the tax bill.

Many investors learn this the hard way. One Reddit user, u/FIFOFrustration, got hit with an extra $837 in taxes because he didn’t select his lots. He thought he could fix it on his tax return. He couldn’t.

How to Use Specific ID on Your Brokerage Platform

Most major brokers - Charles Schwab, Fidelity, TD Ameritrade - let you choose Specific ID. But the interface varies.

Charles Schwab: When you click “Sell,” you’ll see a “Tax Lot Selection” tab. You can sort by cost basis, date, or gain/loss. Pick your lot, confirm, then submit. They also have a “Tax Lot Optimizer” that suggests the best lot based on your tax bracket and holding periods.

Fidelity: After entering your sell order, you get a separate screen to choose lots. You can’t skip this step. It’s more obvious than Schwab’s, but still easy to miss.

Robinhood: They don’t offer lot selection. You’re stuck with FIFO. And their tax reporting is minimal. If you’re serious about taxes, avoid Robinhood for taxable ETFs.

Pro tip: Set up a reminder. Every quarter, open your brokerage account. Look at your tax lots. Sort by cost basis. Note which ones are long-term. Make a mental note: “If I sell this quarter, I’ll pick the $78 lot, not the $42 one.”

What You’re Really Saving: The Numbers Don’t Lie

According to Schwab’s 2022 analysis, investors who used Specific ID saved an average of 44.4% more than those who used FIFO. That’s not a theory. That’s real money.

One investor on r/personalfinance saved $2,145 in 2022 just by picking high-cost lots. He spent 10 minutes per quarter doing it. His brokerage fee was $120 a year. He saved 18 times that.

And it’s not just about short-term gains. If you’re in the 37% tax bracket, selling a $10,000 short-term gain could cost you $3,700. But if you hold that same position for another 6 months, you pay 20% - $2,000. That’s $1,700 saved. Specific ID lets you wait and pick the right time.

Industry reports estimate that proper tax lot management can save investors 0.5% to 1.0% of their portfolio value each year. For a $500,000 portfolio, that’s $2,500 to $5,000. That’s like getting a free raise.

Common Mistakes and How to Avoid Them

• Mistake: Assuming your broker will pick the best lot. Solution: Always check. Don’t rely on defaults.
• Mistake: Selling high-cost shares too early and losing long-term gains. Solution: Keep a list of your cost bases. Hold onto low-basis shares for over a year.
• Mistake: Forgetting to document your choice. Solution: Save the trade confirmation email. Print it if you’re paranoid.
• Mistake: Using Average Cost (only allowed for mutual funds). Solution: ETFs don’t get this option. Don’t confuse the two.

Charles Schwab says 68% of tax lot questions from customers are about forgetting to select, misunderstanding holding periods, or misreading cost basis. You’re not alone. But you can avoid it.

What’s Next? AI Is Taking Over

By 2025, most major brokers will have AI-driven tax optimization built in. Charles Schwab already links its Tax Lot Optimizer with tax-loss harvesting. Fidelity now auto-optimizes lots in IRAs.

The SEC is pushing to standardize how brokers show tax lot options. Right now, it’s a mess. One platform hides it behind three menus. Another makes it the first step. The goal? Less confusion, more savings.

Deloitte predicts AI tools will boost average tax savings from 0.7% to 1.2% of portfolio value by 2025. That’s $6,000 saved per $500,000 portfolio - just by letting software do the math.

But until then? You’re still in charge.

Final Answer: Use Specific ID - But Do It Right

FIFO is lazy. It’s the default. And defaults are designed for people who don’t care about taxes. If you’re reading this, you care.

Specific ID isn’t hard. It takes 5 minutes per trade. You don’t need a CPA. You just need to look at your lots before you sell.

Here’s your checklist:

1. Log into your brokerage account before selling.
2. Find your tax lots (usually under “Cost Basis” or “Tax Reports”).
3. Sort by cost basis - highest to lowest.
4. Choose the lot that minimizes your tax burden.
5. Confirm your selection before clicking “Submit.”
6. Save the confirmation.

Do this every time. Even if you’re only selling 10 shares. Small trades add up.

The IRS isn’t going to change capital gains tax rates tomorrow. But your broker will keep using FIFO unless you tell them otherwise. Don’t let them make your tax decisions for you.