What is the Lot Relief Method
Lot relief method refers to one of five methods of computing the cost basis of an asset. The cost basis is necessary for calculating the taxes on a taxable sale. At least five major lot relief methods can be used. They include FIFO (First-In-First-Out), LIFO (Last-In-First-Out), Dollar Value LIFO, Specific ID (a specific lot of securities or assets are chosen to use for the cost basis) and Average Cost (the average cost basis of all securities or assets purchased is used).
BREAKING DOWN Lot Relief Method
Using the lot relief method can have a substantial impact on the amount of tax that must be paid when an asset is sold. There are several factors that can determine which method is best, including the amount of gain, the amount of income that year versus projected future income and the method that was chosen for previous sales.
When securities are purchased, they comprise a distinct tax lot. The brokerage that processes the transaction is required to track the lot and maintain records related to it such as the date of purchase, the number of shares, and the price. Even when an additional purchase made of a security that is already owned, a separate tax lot is recorded.
When the security is sold, the brokerage may use various methods to select the lot from which the sold securities are sold. The First In, First Out method sells those that were purchased first. The Last In, Last Out method sells those that were purchased last. Dollar Value LIFO is a variation of LIFO that pools securities and measures increases and decreases in terms of the total dollar value. The Specific ID method allows the investor to specify which lot he/she would like to sell. The Average Cost method uses an average of a pool of assets. This method may be permitted only certain transactions.