ETF Tax Lot Management: Specific ID vs FIFO - How to Save Thousands on Capital Gains

When you sell ETF shares, the IRS doesn’t care that you bought them at different prices over time. It only cares about which shares you sold - and that choice can mean the difference between paying $1,350 in taxes or just $600 on the same $10,000 sale. This isn’t theory. It’s real money, and it’s controlled by something called tax lot management.

Most brokerage accounts default to First In, First Out (FIFO). That means if you bought 100 shares of an ETF at $10 a share five years ago, and another 100 at $65 a share three months ago, FIFO will automatically sell the $10 shares first when you sell 100 shares today. Even if the market price is $100, you’re stuck with a $9,000 capital gain - and a $1,350 tax bill at the 15% long-term rate. But what if you could pick the $65 shares instead? Your gain drops to $3,500. Your tax? $840. That’s $510 saved on one trade.

What Are Tax Lots, Really?

Every time you buy ETF shares in a single transaction, you create a tax lot. That lot has three things: the number of shares, the price you paid, and the date you bought them. If you bought 50 shares of VTI on January 10 at $215, that’s one lot. Then you bought another 30 on March 15 at $220 - that’s a second lot. Sell 40 shares? The IRS treats those as coming from specific lots, not an average.

These lots determine whether your gain is short-term (held less than a year) or long-term (held over a year). Short-term gains are taxed at your ordinary income rate - up to 37% in 2025. Long-term gains? Max 20%. That gap is where the real savings live.

FIFO: The Default That Costs You

FIFO is automatic. It’s simple. And it’s often the worst choice for tax efficiency.

Imagine you bought 100 shares of QQQ at $300 in 2020, then another 100 at $450 in 2023. Today, QQQ trades at $500. You sell 100 shares. FIFO says: sell the 2020 shares. Your gain? $200 per share. $20,000 total. Taxed at 20% = $4,000.

But what if you sold the 2023 shares instead? Gain? $50 per share. $5,000 total. Taxed at 20% = $1,000. You just saved $3,000 - not because the market moved, but because you picked the right lot.

FIFO doesn’t care about your goals. It doesn’t know you’re trying to preserve older shares for long-term growth. It doesn’t know you want to offset gains with losses elsewhere in your portfolio. It just sells the oldest. And in rising markets, that’s the most expensive path to taxes.

Specific Identification: The Power Move

Specific Identification (Specific ID) lets you choose exactly which tax lot to sell. You pick the shares. Not your broker. Not the system. You.

This is how professional investors and tax-savvy individuals control their tax bills. You can:

• Sell the highest-cost lot to minimize your gain
• Sell a short-term lot to offset a capital loss you’ve already harvested
• Sell a long-term lot to lock in the lower 20% rate
• Hold onto low-basis shares for heirs - they get a step-up in basis at death

Here’s a real example from a Schwab client: A $10,000 sale using FIFO triggered $9,000 in gains and $1,350 in taxes. With Specific ID, the investor picked a lot with a $6,500 cost basis. Gain dropped to $3,500. Tax dropped to $840. Savings: $510. That’s 55% less in taxes - just by choosing.

How to Use Specific ID (Step-by-Step)

It’s not magic. It’s procedure. And you have to act before you sell.

1. Log into your brokerage account (Schwab, Fidelity, TD Ameritrade, etc.).
2. Go to the trade screen for the ETF you want to sell.
3. Look for a link or button labeled “Tax Lot Selection”, “Choose Shares to Sell”, or “Cost Basis”.
4. You’ll see a list of your lots: date, shares, price, gain/loss.
5. Select the lot you want to sell. You can sort by cost basis, date, or gain.
6. Confirm your selection - before clicking “Buy” or “Sell.”
7. Check your confirmation email or trade receipt. It should show which lot was sold.

Here’s the catch: You must specify the lot before the trade executes. The IRS doesn’t allow you to pick after the fact. If you forget, you get FIFO - and you can’t change it later.

Brokerage Platform Differences

Not all platforms make Specific ID easy.

Charles Schwab has the most user-friendly system. Their Tax Lot Optimizer even suggests the best lot to sell based on your tax goals. It’s built into the trade flow. You don’t have to hunt for it.

Fidelity lets you choose lots, but you often have to click through an extra screen after placing the order but before execution. Easy to miss.

TD Ameritrade has the feature, but their interface is cluttered. 34% of their users report confusion, according to Kiplinger’s 2023 survey.

Robinhood barely explains it. Their tax lot documentation is thin. Users get FIFO by default - and often don’t realize it until tax season.

Bottom line: If you’re serious about tax efficiency, pick a broker that makes Specific ID obvious - and use it every time.

When FIFO Might Be Okay

FIFO isn’t always bad. It can make sense if:

• You’ve only bought ETF shares once or twice
• All your lots are long-term
• You’re selling a small amount and don’t care about the tax impact
• You’re using a tax-advantaged account (IRA, 401(k)) - where taxes don’t matter until withdrawal

But if you’ve bought ETFs over multiple years, in different market conditions - and you’re in a taxable account - FIFO is like leaving money on the table.

Common Mistakes and How to Avoid Them

People mess this up all the time. Here’s what goes wrong:

• Forgetting to select a lot → Broker defaults to FIFO. Save: $0.
• Confusing trade date with settlement date → IRS requires selection before trade execution, not settlement. Don’t wait.
• Not tracking cost basis → If you bought through a dividend reinvestment plan, your cost basis is higher than you think. Check your statements.
• Trying to backdate selections → IRS says no. You can’t pick after the fact, even if you’re filing taxes.

Fix it: Set a quarterly reminder. Spend 10 minutes reviewing your tax lots. Use your broker’s tools. If you’re unsure, talk to a tax pro.

The Bigger Picture: Why This Matters Now

In 2025, over 42% of U.S. household financial assets are in taxable accounts - up from 38% in 2018. That’s more money exposed to capital gains taxes than ever before.

Brokers now report your cost basis and tax lots to the IRS on Form 1099-B. The IRS is cross-checking those numbers against your tax return. If you sell a lot and report the wrong gain, you’ll get a notice. You don’t want that.

Meanwhile, tax optimization tools are getting smarter. Schwab’s optimizer processed 14.7 million tax-sensitive trades in 2022. Fidelity rolled out auto-optimization for IRAs in mid-2023. Deloitte predicts AI-driven tax lot tools will be standard by 2025 - saving investors up to 1.2% of portfolio value annually.

That’s not a small win. For a $500,000 portfolio, that’s $6,000 a year. And it’s all from choosing the right shares to sell.

Final Thought: It’s Not About Timing the Market

You don’t need to predict the next crash. You don’t need to chase hot sectors. You just need to know which shares you’re selling - and why.

Specific ID isn’t a trick. It’s a basic tool, like checking your tire pressure before a road trip. Most people ignore it. The ones who don’t? They keep more of their money. And that’s the whole point of investing.