Highest-In/First-Out (HIFO) Tax Lot Accounting
Text says: If tax rates are high and expected to fall it could be beneficial to recognise the tax alpha today. If tax rates are low and expected to rise, could be beneficial to wait and recognise a larger tax alpha later.
But ff tax will fall later, isn’t it better to wait and pay the lower tax on your tax alpha later on? Similarly, if tax will rise later, shouldn’t we pay lower tax now on the higher alpha, rather than wait?
Any insights please
I think they assume that you have losses that you may harvest. With Hifo, you’ll sell your highest first, and could realize some losses. higher tax->higher profit.
I believe HIFO is used when u want to harvest the tax loss. so, if the rates are high, the realized losses are magnified and you can use that against the realized gains and vice versa.
Tax lot methods only come into play when you’re selling a portion of the position or rebalancing.
Large Losses & Large Gains - You want to use LIFO tax lots (Lowest In) as you will be selling the lower cost basis positions with large gains that can be offset with sellling positions with large unrealized losses.
No Losses & Large Gains - You want to use HIFO as you will be selling the highest cost basis positions with the smallest gains.
HIFO is beneficial irrespective of losses.
‘Highest in’ simply states using the highest cost basis first to subtract from the gain. If taxes are high today —> High Cost basis reduces tax paid —> High Tax Alpha. (Think during high taxes you want to show least profit)
Lowest Cost basis if Taxes are low today (LIFO)