Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

If an investor does not use Specific Identification when selling securities, the IRS assumes __________________.

1. Last-in, first-out (LIFO)

2. First-in, first-out (FIFO)

3. Average cost basis

4. Any method at their discretion

The correct answer is: First-in, first-out (FIFO)

When an investor does not explicitly choose a method for identifying which shares of stock are sold during a transaction, the IRS defaults to the First-in, First-out (FIFO) methodology. This means that the shares that were purchased first are assumed to be sold first. This is important for calculating capital gains or losses because it can significantly affect the amount of tax owed. The FIFO method typically results in lower capital gains when prices are rising, as the investor is selling shares that had a lower purchase price compared to more recently acquired, higher-priced shares. This leads to potentially higher capital gains if the sale occurs during a market upswing. Employing FIFO is a standard practice for accounting and tax purposes unless the investor specifically uses the Specific Identification method, wherein they designate which shares are being sold. This aspect highlights the necessity for investors to actively manage their trade confirmations and transaction records to ensure they align with their intended tax outcomes.