The LIFO strategy is a way of calculating capital gains. It is used when people are trying to minimize their capital gain.
This is because, usually, the last shares you bought will have a price that is closest to what you are selling them for.
The strategy is simple, when calculating the capital gain, you process trades in order of most recent purchases.
The last trade purchased = the first one out.
Let’s look at an example of LIFO:
Purchases:
- Buy 10 shares at $1 each — Total cost: $10
- Buy 10 shares at $5 each — Total cost: $50
Sale:
- Sell 10 shares at $4 each — Total sale value: $40
LIFO Calculation:
- Last parcel: 10 shares at $5 each — Total cost: $50
- Sold 10 shares for $40
Capital Gain:
- Gain: $40 (sale value) — $50 (cost) = $-10
Since this results a capital loss, it is not subject to capital gains tax.
This loss can then be used to offset other capital gains or be carried forward to future financial years.
A more complex LIFO example.
Suppose we buy the following parcels in company ABC:
- Buy 10 shares at $2 each — Total: $20
- Buy 5 shares at $5 each — Total: $25
- Buy 10 shares at $3 each — Total: $30
This gives us a total of 25 shares at different price points.
Now, let’s sell 13 shares at $4 per share using the LIFO (Last-In-First-Out) method.
First Parcel (a):
- 10 shares at $3 each.
- Total cost: $30
- Sale value: 10 shares x $4 = $40
- Gain: $40 — $30 = $10
Second Parcel (b):
- Remaining 3 shares to be sold.
- Next parcel: 5 shares at $5 each.
- Cost for 3 shares: 3 shares x $5 = $15
- Sale value: 3 shares x $4 = $12
- Loss: $12 — $15 = -$3
Total Capital Gain:
- Gain from first parcel: $10
- Loss from second parcel: -$3
- Total gain: $10 – $3 = $7
Therefore, the total capital gain from selling 13 shares is $7.
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