An investor who bought shares repeatedly and sells only some of them faces a question with no physical answer: which shares were sold. The accounting method chosen determines what gets reported.
Shares are fungible, so a rule is required
Shares of the same security bought at different times are identical in every respect except the price paid for them. Nothing physically distinguishes one lot from another.
When a partial sale occurs, the gain depends entirely on which purchase price is matched against the sale price, and those prices can differ substantially.
Because there is no natural answer, tax rules supply methods for making the determination consistently, and brokers apply whichever method governs the account at the time of sale.
The default is not always what an investor expects
In the absence of a specific instruction, brokers generally apply a default method, and first-in first-out is common for individual securities.
That default matches the oldest purchases against the sale, which in a long-held position often means the lowest cost lots are used first.
Mutual fund positions frequently default to an average cost method instead, which treats all shares as having a single blended basis. The distinction is easy to overlook because both appear identically on a statement.
Specific identification requires timely instruction
Specific identification lets an investor designate which lots are sold, but the designation generally must be made at or before settlement rather than reconstructed later.
Once a trade settles under the default method, the reporting is set, and changing it afterward is not simply a matter of preference.
This is why the mechanics of how a brokerage platform accepts lot selection matter as much as knowing the method exists.
Basis reporting is now largely broker-provided
Brokers report cost basis for covered securities directly to tax authorities, so the figures on a year-end statement flow into the return.
Securities acquired before basis reporting rules took effect, or transferred between institutions, may carry incomplete records that the investor has to substantiate.
Transfers between custodians are a common source of gaps, since basis information does not always travel as reliably as the shares themselves.
Holding period travels with the lot
Whether a gain is treated as short-term or long-term depends on how long the specific shares deemed sold were held.
Selecting different lots can therefore change the character of the result as well as its amount, since lots purchased at different times have different holding periods.
Rules governing basis, holding periods and reporting vary by account type and change over time, so the current rules and an individual's own circumstances are matters for a qualified tax professional.