With 2020 tax bills coming due, a wave of new retail traders are waking up to the fact that it can be difficult, and often impossible, to make tax-minimizing moves on new brokerage platforms such as Robinhood, Webull, SoFi, Uphold and Public.com. Some don’t allow trading within tax-favored retirement accounts such as IRAs. Traders can also find it hard to track their “wash sales” that reduce tax benefits if they buy a stock within 30 days of selling the same stock at a loss. Most vexing for investors like Mr. Leong is that despite the new platforms’ sophisticated technology they don’t make it easy to deploy a tax-wise technique known as “specific-lot identification.” Investors use it to lower their taxes, sometimes significantly, by choosing which shares to sell if they have lots bought at different prices and aren’t selling all of them.
Here’s why this issue matters. Tax laws allow investors with taxable accounts to use the losses they incur when they sell a stock that’s dropped to offset the taxes on gains from the sales of stocks that have climbed. The losses can also offset up to $3,000 of other income, such as wages, each year. Unused losses carry forward for use against future gains and other income. The option of selling specific lots is readily available at traditional brokerage firms. But Webull, SoFi, Public and Uphold don’t allow it, and Robinhood makes it difficult. This fact shocks professional money managers.
Smart use of specific-lot identification can minimize current tax bills. Say that a trader holds Tesla shares bought at $400, $650 and $850 apiece since mid-September, 2020. If this person decided to sell some of the winners at a recent price of $675, the taxable gain would be either $275 or $25 per share, depending on which shares were sold. That’s a big difference—and it’s even bigger if some $850 shares were sold, bringing a loss of $175 per share that could offset taxable gains.
On Robinhood’s webpage about tax lots, the firm doesn’t tell customers they have the option of selling specific lots. Instead, it says sales will be on a first-in-first-out basis, known as FIFO, in which oldest shares are sold first. While FIFO could lower tax rates if the oldest shares have been held longer than a year, it might not. In the Tesla example above, FIFO would give the trader conceivably the worst outcome—a short-term gain of $275 per share, taxed at the rates for ordinary income like wages. In the fine print of trade confirmations sent to customers after they’ve sold shares, Robinhood does offer the option of specifying lots. But the process is complicated.
Other new platforms don’t allow specific-lot ID at all. Both Webull and Public mandate FIFO for sales, while Uphold sells the most expensive shares available (called highest-in-first-out, or HIFO), and SoFi orders lots so that losers are typically sold before winners.