This is a continuation of last week’s blog about differences in Capital Gains between Canada and the US.

If you missed last week’s post, you can find it here:

Bird's Eye Wealth Planners | Capital Gains Canada vs US (birdseyewealth.com)

Now that we have learned that the process of calculating Capital Gains are very different between the two countries, it’s time to really have some fun.

Let’s talk about Lot Accounting!

Last week’s post we used very simple examples of a single buy and sell. For most investors, they are actually buying the same holding multiple times.

If you’ve automated your savings (big fan by the way!) then you aren’t buying at one price but at a bunch of different prices over time.  

When you have multiple purchases of the same investment product, it’s your responsibility to calculate what you paid for all these purchases and provide this information to the CRA or IRS when you sell.

In Canada, we use an average cost accounting in all investment accounts. That means your role is to calculate the average cost of ALL your purchases and then use this average figure to calculate your capital gain or loss.

Life is better with an example.

I decide to buy 100 shares of my favourite ETF but I only have enough money to buy 50 this month and the second 50 next month.

In August I bought 50 at a price of $10 for a total cost of $500.

In September I bought another 50 but at a price of $11 for a total cost of $550. I know own 100 shares and my total purchase cost is $1050 or $10.50 per share.

A year later I want to sell 50 of my 100 shares and the price has risen to $13 per share. I sell 50 shares at $13 and receive $650 in proceeds. My calculation for the capital gain uses the average price of my two purchases.

$650 proceeds - $525 average cost ($10.50 per share x 50) for a gross capital gain of $125.

The good news is this average cost calculation is easily repeatable over any number of transactions and will adjust over time with your buying or dividend reinvestment plans.

In Canada, this is the only way we do it when calculating Capital Gains

In the US, well it’s way more complicated!

Welcome to the wonderful world of Lot Accounting and the acronyms FIFO and LIFO.

Lot Accounting is the process where every purchase you make has its own cost and date associated with it. Remember that the US Capital Gains system divides the tax implications between an investment held for 1 year or less (short-term gain) or longer than 1 year (long-term gain)

Because each purchase is treated as a different entity for accounting purposes, this gives rise to FIFO or LIFO rules.

FIFO, or First In, First Out is the default system and it means that when determining whether a gain falls under the Short-term rules or Long-term rules, you are considered to have sold the earliest purchases first. Hence first in, first out.

Last In, First Out (aka LIFO) uses the most recent purchases when calculating the short-term vs long-term capital gains impact. This seems strange to do, especially when you run the risk of having a gain charged at the higher Short-term gains tax rate.

So why would you consider using LIFO?

Well, this is why tax-loss harvesting is a much bigger thing in the US than here in Canada. If all you have is a single transaction in a year, you’re most likely to want to realize long-term gains.

But most portfolios aren’t like that and there are multiple sales in any given year and a mix of gains AND losses. It might make sense to use LIFO accounting to offset short-terms gains. It might even make sense to use a loss to reduce your income by the maximum $3000 and lower your overall income tax rate!

But remember this, FIFO is the DEFAULT system used, and most investment brokers will report everything using the FIFO system.

It is vitally important that you keep accurate records of each purchase Lot so you can provide the proper information if you want to use LIFO. You also need to notify your broker and ask for written confirmation they have used LIFO accounting as you instructed.

The responsibility is on YOU as the taxpayer to make sure your reporting is correct.

The seasoned tax people that read this will note I skipped by one other method of Lot Accounting, Highest In, First Out or HIFO. An individual investor is able to use this method when calculating their capital gains but given its complexity compared to LIFO, I encourage you to consult a tax professional long before you consider using it.

That’s a quick primer on Lot Accounting and the US FIFO/LIFO rules.

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-FIN-