Save on Taxes: Know Your Cost Basis

February 6, 2026 Hayden Adams
Whether you're a newbie or seasoned investor, determining your tax cost basis can help you save on taxes. Here's how.

When you sell appreciated assets in a taxable brokerage account, you could end up triggering a tax bill from the resulting capital gain. The size of the bill will depend in part on how long you've held the assets, as well as how much you originally paid for them—known as the assets' "cost basis."

Here's what to know.

What is cost basis?

As noted, your cost basis is what you paid for an investment. It includes brokerage fees, "loads" (i.e., one-time commissions that some fund companies charge whenever you buy or sell shares in mutual funds), and other trading costs, and it can be adjusted to reflect corporate actions, such as mergers and stock splits.

Cost basis matters because it's the starting point for any calculation of a capital gain or loss. If you sell an investment for more than its cost basis, you'll have a capital gain. If you sell it for less, it's a capital loss.

Calculating your cost basis is generally pretty straightforward, but there are exceptions. For example, if you buy multiple blocks of the same investment, like through a dividend reinvestment plan, each block will likely have a different cost basis and holding period.

Note: The cost basis for bonds can be a bit more complicated based on whether you bought them at "par" (face value), paid a premium, or got a discount.

Cost basis methods

When you open a brokerage account, a default cost basis method is assigned to your investments. However, just because it's the default doesn't mean you should use it every time, as your needs and goals for each transaction may vary.

Listed below are the cost basis methods available at Schwab. Other firms may have different options that aren't covered here.

Note: For Schwab clients with accounts opened before October 2024, the average cost method was the default method for qualified securities, known as Regulated Investment Companies (more on that below). From October 2024 onward, newly opened accounts holding Regulated Investment Companies use the first-in, first-out (FIFO) as the default method. For all other security types, FIFO remains the default method.

Average cost method

The average cost basis method is generally available for qualified securities. Qualified securities are domestic corporations registered as Regulated Investment Companies (RICs). RICs include mutual funds as well as certain Exchange Traded Funds (ETFs) and Unit Investment Trusts (UIT).

The average cost basis method is calculated by taking the total cost of the shares you own and dividing by the total number of the shares you hold. So, imagine you invested $10,000 in a mutual fund over the years and now have 125 shares of a particular fund. If you were using the average cost basis method, any shares you sold would have a cost basis of $80 ($10,000 ÷ 125)—regardless of whether you originally paid more or less than that for each share.

Implications: The average cost basis method isn't necessarily the best or the worst option. As its name suggests, it'll generally produce "average" results from a tax perspective. However, simplicity makes it a good choice for those looking for a straightforward cost basis method. For example, average cost basis reporting can be useful if you reinvest dividends or regularly purchase additional shares of a specific fund, as you may not wish to identify the original purchase price of each share to calculate your overall cost basis for the transaction.

Implications: The average cost basis method isn't necessarily the best or the worst option. As its name suggests, it'll generally produce "average" results from a tax perspective. However, simplicity makes it a good choice for those looking for a straightforward cost basis method. For example, average cost basis reporting can be useful if you reinvest dividends or regularly purchase additional shares of a specific fund, as you may not wish to identify the original purchase price of each share to calculate your overall cost basis for the transaction.

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Implications: The average cost basis method isn't necessarily the best or the worst option. As its name suggests, it'll generally produce "average" results from a tax perspective. However, simplicity makes it a good choice for those looking for a straightforward cost basis method. For example, average cost basis reporting can be useful if you reinvest dividends or regularly purchase additional shares of a specific fund, as you may not wish to identify the original purchase price of each share to calculate your overall cost basis for the transaction.

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Implications: The average cost basis method isn't necessarily the best or the worst option. As its name suggests, it'll generally produce "average" results from a tax perspective. However, simplicity makes it a good choice for those looking for a straightforward cost basis method. For example, average cost basis reporting can be useful if you reinvest dividends or regularly purchase additional shares of a specific fund, as you may not wish to identify the original purchase price of each share to calculate your overall cost basis for the transaction.

First-in, first-out method (FIFO)

FIFO automatically assumes you're selling shares you held the longest.

Implications: Because asset prices tend to rise over time, relying on the FIFO method as your default could potentially lead to a higher tax bill on a sale, as the shares you've held longest would theoretically have appreciated the most. Of course, if you're looking to book the most gains, FIFO might make sense for that particular sale. Similarly, if you bought your oldest shares at the highest prices, say, because you bought them before the market dropped, FIFO could work in your favor. Keep in mind, too, that FIFO doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a gain is realized.

Implications: Because asset prices tend to rise over time, relying on the FIFO method as your default could potentially lead to a higher tax bill on a sale, as the shares you've held longest would theoretically have appreciated the most. Of course, if you're looking to book the most gains, FIFO might make sense for that particular sale. Similarly, if you bought your oldest shares at the highest prices, say, because you bought them before the market dropped, FIFO could work in your favor. Keep in mind, too, that FIFO doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a gain is realized.

short-term capital gains sales, which could result in a higher tax rate if a gain is realized.

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Implications: Because asset prices tend to rise over time, relying on the FIFO method as your default could potentially lead to a higher tax bill on a sale, as the shares you've held longest would theoretically have appreciated the most. Of course, if you're looking to book the most gains, FIFO might make sense for that particular sale. Similarly, if you bought your oldest shares at the highest prices, say, because you bought them before the market dropped, FIFO could work in your favor. Keep in mind, too, that FIFO doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a gain is realized.

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Implications: Because asset prices tend to rise over time, relying on the FIFO method as your default could potentially lead to a higher tax bill on a sale, as the shares you've held longest would theoretically have appreciated the most. Of course, if you're looking to book the most gains, FIFO might make sense for that particular sale. Similarly, if you bought your oldest shares at the highest prices, say, because you bought them before the market dropped, FIFO could work in your favor. Keep in mind, too, that FIFO doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a gain is realized.

Last-in, first-out method (LIFO)

LIFO assumes the shares most recently purchased are the first ones sold.

Implications: Using LIFO as your default would mean selling your most recently acquired shares first. In a rising market, that would generally result in the highest cost basis and therefore a potentially smaller capital gain from sales. However, if the most recent shares were purchased within a year, the gains realized will be taxed at higher short-term capital gain rates.

Implications: Using LIFO as your default would mean selling your most recently acquired shares first. In a rising market, that would generally result in the highest cost basis and therefore a potentially smaller capital gain from sales. However, if the most recent shares were purchased within a year, the gains realized will be taxed at higher short-term capital gain rates.

Low-cost lot method

With the low-cost lot method, shares with the lowest cost basis are sold first, regardless of when you bought them.

Implications: The low-cost lot method will result in the highest capital gain (or smallest capital loss on a losing position), which may result in a higher current tax burden. For that reason, this method generally isn't recommended for those trying to reduce their current year taxable income. In addition, this method doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a short-term gain is realized.

Implications: The low-cost lot method will result in the highest capital gain (or smallest capital loss on a losing position), which may result in a higher current tax burden. For that reason, this method generally isn't recommended for those trying to reduce their current year taxable income. In addition, this method doesn't specifically avoid short-term capital gains sales, which could result in a higher tax rate if a short-term gain is realized.

High-cost lot method

With the high-cost lot method, shares with the highest cost basis are sold first, regardless of when you bought them.

Implications: The high-cost lot method results in the lowest capital gains (or the greatest amount of realized losses) for a sale. This method may be appropriate if you want to reduce your taxable capital gains or are interested in tax-loss harvesting. However, this method also doesn't specifically avoid short-term capital gains, which could result in a higher tax rate if a short-term gain is realized.

Implications: The high-cost lot method results in the lowest capital gains (or the greatest amount of realized losses) for a sale. This method may be appropriate if you want to reduce your taxable capital gains or are interested in tax-loss harvesting. However, this method also doesn't specifically avoid short-term capital gains, which could result in a higher tax rate if a short-term gain is realized.

tax-loss harvesting. However, this method also doesn't specifically avoid short-term capital gains, which could result in a higher tax rate if a short-term gain is realized.

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Implications: The high-cost lot method results in the lowest capital gains (or the greatest amount of realized losses) for a sale. This method may be appropriate if you want to reduce your taxable capital gains or are interested in tax-loss harvesting. However, this method also doesn't specifically avoid short-term capital gains, which could result in a higher tax rate if a short-term gain is realized.

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Implications: The high-cost lot method results in the lowest capital gains (or the greatest amount of realized losses) for a sale. This method may be appropriate if you want to reduce your taxable capital gains or are interested in tax-loss harvesting. However, this method also doesn't specifically avoid short-term capital gains, which could result in a higher tax rate if a short-term gain is realized.

Tax Lot Optimizer™

The Tax Lot Optimizer uses an algorithm to calculate the optimal way to minimize the tax impact of each sale. In general, the goal is to sell investments for losses first (short-term losses, then long-term losses) and gains last (long-term gains, then short-term gains).

Implications: Like with the high-cost lot method, the Tax Lot Optimizer looks for the highest cost shares first, but the algorithm also considers the holding period of each share. This method can be a good option for investors seeking to minimize taxes or harvest losses. But be aware, although this method tries to avoid short-term capital gains, that's not always possible if shares have been held less than one year.

Implications: Like with the high-cost lot method, the Tax Lot Optimizer looks for the highest cost shares first, but the algorithm also considers the holding period of each share. This method can be a good option for investors seeking to minimize taxes or harvest losses. But be aware, although this method tries to avoid short-term capital gains, that's not always possible if shares have been held less than one year.

Specified lot method (a.k.a. specific identification)

When placing a sell order, you can identify specific lots of shares to sell. This method gives you the most control over your cost basis. Unfortunately, it can't serve as your account's default method because it can't be automated—you must manually select each share you want to sell.

Implications: The specified lot method can be used to target the exact shares you want to sell, offering the most flexibility and control over your taxes. Using this method allows you to avoid realizing short-term capital gains and wash sales when tax-loss harvesting, and you can target a certain amount of capital gains to fill up a tax bracket. But that control comes at a cost: It is the most labor intensive, and it could end up costing you more if you use a tax advisor to assist you in the process of selecting shares.

Implications: The specified lot method can be used to target the exact shares you want to sell, offering the most flexibility and control over your taxes. Using this method allows you to avoid realizing short-term capital gains and wash sales when tax-loss harvesting, and you can target a certain amount of capital gains to fill up a tax bracket. But that control comes at a cost: It is the most labor intensive, and it could end up costing you more if you use a tax advisor to assist you in the process of selecting shares.

wash sales when tax-loss harvesting, and you can target a certain amount of capital gains to fill up a tax bracket. But that control comes at a cost: It is the most labor intensive, and it could end up costing you more if you use a tax advisor to assist you in the process of selecting shares.

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Implications: The specified lot method can be used to target the exact shares you want to sell, offering the most flexibility and control over your taxes. Using this method allows you to avoid realizing short-term capital gains and wash sales when tax-loss harvesting, and you can target a certain amount of capital gains to fill up a tax bracket. But that control comes at a cost: It is the most labor intensive, and it could end up costing you more if you use a tax advisor to assist you in the process of selecting shares.

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Implications: The specified lot method can be used to target the exact shares you want to sell, offering the most flexibility and control over your taxes. Using this method allows you to avoid realizing short-term capital gains and wash sales when tax-loss harvesting, and you can target a certain amount of capital gains to fill up a tax bracket. But that control comes at a cost: It is the most labor intensive, and it could end up costing you more if you use a tax advisor to assist you in the process of selecting shares.

Using cost basis methods to lower taxes

Say you bought 500 shares of the ZYX fund 10 years ago for $10 per share for a total cost of $5,000 (for the sake of simplicity, we'll ignore commissions on all the trades). Five years later, you bought a second block of 500 shares for $60 per share ($30,000 total). Finally, 10 months ago, you bought 200 shares for $65 each ($13,000 total).

Today, the fund's share price is trading at $100, and you decide to sell 100 shares. You're currently in the 15% long-term capital gain tax bracket and 24% short-term capital gain tax bracket.

If you wanted to minimize the taxes on this transaction, which cost basis method would you choose?

In this example, the Tax lot Optimizer and specified lot methods produced the lowest taxes due of $600 (in green) compared to the least tax-efficient methods of FIFO and low-cost with taxes of $1,350 (in red). Notice how the smallest capital gains were realized using the LIFO and high-cost methods ($3,500); however, the taxes were not the lowest at $840. This is because the methods are realizing short-term capital gains, which are taxed at a higher rate.

But remember, this is just an example. To determine the best methods for your particular situation, consider meeting with a financial or tax advisor.

  • Cost basis of shares sold
  • Taxable capital gain
  • Tax on gain
  • Average
  • Cost basis of shares sold
    $4,000 (100 shares x $40)
  • Taxable capital gain
    $6,000 ($10,000 – $4,000)
  • Tax on gain
    $900 ($6,000 x 15%) 
  • FIFO
  • Cost basis of shares sold
    $1,000 (100 shares x $10) 
  • Taxable capital gain
    $9,000 ($10,000 – $1,000) 
  • Tax on gain
    $1,350 ($9,000 x 15%)
  • LIFO
  • Cost basis of shares sold
    $6,500 (100 shares x $65) 
  • Taxable capital gain
    $3,500 ($10,000 – $6,500) 
  • Tax on gain
    $840 ($3,500 x 24%) 
  • Low cost
  • Cost basis of shares sold
    $1,000 (100 shares x $10) 
  • Taxable capital gain
    $9,000 ($10,000 – $1,000) 
  • Tax on gain
    $1,350 ($9,000 x 15%) 
  • High cost
  • Cost basis of shares sold
    $6,500 (100 shares x $65) 
  • Taxable capital gain
    $3,500 ($10,000 – $6,500) 
  • Tax on gain
    $840 ($3,500 x 24%) 
  • Tax Lot Optimizer
  • Cost basis of shares sold
    $6,000 (100 shares x $60) 
  • Taxable capital gain
    $4,000 ($10,000 – $6,000) 
  • Tax on gain
    $600 ($4,000 x 15%) 
  • Specified lot
  • Cost basis of shares sold
    $6,000 (100 shares x $60) 
  • Taxable capital gain
    $4,000 ($10,000 – $6,000) 
  • Tax on gain
    $600 ($4,000 x 15%) 

Identifying shares and setting your default cost basis method

How do you identify the specific shares you want to sell?

If you're placing the order by phone, tell your broker which shares you want to sell (for example, "the shares I bought on July 5, 2012, for $11 each").

At Schwab, if you place the order online, you'll see your cost basis method on the order entry screen. If you select the specified lot method, you'll be able to specifically identify which shares you want to sell.

To change your default cost basis method, log in to your Schwab.com account and select your account icon in the upper right corner and select Account Settings. This brings up a page where you can change your cost basis method for each of your accounts.

Reporting rules for cost basis

Brokerage firms are only required to report your cost basis to the IRS when you sell an investment purchased after one of the following dates:

  • Equities (stocks, including real estate investment trusts, or REITs) acquired on or after January 1, 2011
  • Mutual funds, ETFs, and dividend-reinvestment plans acquired on or after January 1, 2012
  • Other specified securities, including most fixed income securities (generally bonds) and options acquired on or after January 1, 2014

Whether or not a brokerage reports your cost basis to the IRS, you're still responsible for reporting the correct amount when you file your taxes.

Brokerage firms are only required to report your cost basis to the IRS when you sell an investment purchased after one of the following dates:

  • Equities (stocks, including real estate investment trusts, or REITs) acquired on or after January 1, 2011
  • Mutual funds, ETFs, and dividend-reinvestment plans acquired on or after January 1, 2012
  • Other specified securities, including most fixed income securities (generally bonds) and options acquired on or after January 1, 2014

Whether or not a brokerage reports your cost basis to the IRS, you're still responsible for reporting the correct amount when you file your taxes.

So, which method should you choose?

Because each investment you purchase could have a different cost basis and holding period, no single automated cost basis method will work perfectly in every situation. Each method has its benefits and downsides, depending on what you're trying to accomplish.

Generally, we suggest investors specifically identify the shares they want to sell on every trade, because this offers the most control over the gain or loss realized. The specified lot method offers the potential to maximize tax efficiency—especially if you use other tax-smart strategies, such as tax-loss harvesting, tax-gain harvesting, or donating appreciated assets to your favorite charity.

If you're looking for a cost basis method that is automated, and you also want to minimize taxes, we generally suggest using the Tax Lot Optimizer. This method can offer a high level of tax efficiency but with less effort of selecting each individual share to sell.

Whichever method you decide to use, it's important to plan ahead, so you aren't stuck with a huge tax bill come tax season. To truly maximize the tax benefits of each method, its best to work with a tax professional and/or wealth manager who can help you implement a holistic tax and financial plan.

This material is intended for general informational and educational purposes only. This should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned are not suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decisions.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

​For illustrative purposes only. Individual situations will vary. Not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

​Past performance is no guarantee of future results.

This information is not a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager, Estate Attorney) to help answer questions about specific situations or needs prior to taking any action based upon this information. Certain information presented herein may be subject to change. The information or material contained in this document may not be copied, assigned, transferred, disclosed or utilized without the express written approval of Schwab.

All names and market data shown are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

Charles Schwab & Co., Inc. does not represent that any particular tax consequences will be obtained. Before executing any tax strategies ensure you understand the technicalities and certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service ("IRS") website at http://www.irs.gov about the potential tax consequences.

Neither the tax-loss harvesting strategy, nor any discussion herein, is intended as tax advice and Charles Schwab & Co., Inc. does not represent that any particular tax consequences will be obtained. Tax-loss harvesting involves certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service (IRS) website at www.irs.gov about the consequences of tax-loss harvesting.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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This material is intended for general informational and educational purposes only. This should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned are not suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decisions.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

​For illustrative purposes only. Individual situations will vary. Not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

​Past performance is no guarantee of future results.

This information is not a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager, Estate Attorney) to help answer questions about specific situations or needs prior to taking any action based upon this information. Certain information presented herein may be subject to change. The information or material contained in this document may not be copied, assigned, transferred, disclosed or utilized without the express written approval of Schwab.

All names and market data shown are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

Charles Schwab & Co., Inc. does not represent that any particular tax consequences will be obtained. Before executing any tax strategies ensure you understand the technicalities and certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service ("IRS") website at http://www.irs.gov about the potential tax consequences.

Neither the tax-loss harvesting strategy, nor any discussion herein, is intended as tax advice and Charles Schwab & Co., Inc. does not represent that any particular tax consequences will be obtained. Tax-loss harvesting involves certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service (IRS) website at www.irs.gov about the consequences of tax-loss harvesting.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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