What Is Tax Lot Allocation And Why Could Retail Traders Be 'Making A Very Expensive Mistake'?

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Americans have until May 17 to file their 2020 taxes after the tax deadline was bumped back to provide more financial flexibility for taxpayers struggling through the pandemic. Unfortunately, many retail traders may end up paying far more in capital gains taxes than they need to this tax season.

The Wall Street Journal recently reported that Robinhood’s app doesn’t provide its users with an easy way to utilize a tax savings technique called tax lot allocation.

What Is Tax Lot Allocation? Here’s how tax lot allocation works:

  • Tax rates on long-term capital gains, or stocks held for at least one year, are much lower than tax rates on short-term capital gains, which are taxes as regular income. However, many active traders will buy and sell the same stocks dozens of times per year.
  • Each time a trader buys shares of stock, that trade comes with a specific transaction date and a specific cost basis. Investors can use tax lot allocation to determine which lot or lots of a specific stock they want to sell at a particular time to minimize their capital gains taxes.
  • However, tax lot allocation is difficult on the Robinhood platform. It’s also completely impossible on other popular online trading apps, including Webull, SoFi, Public and Uphold.
  • Related Link: Could Long-Term Capital Gains Selling Be Weighing On The Market?

Robinhood’s System: Robinhood’s app is set up to automatically sell the lot that has the oldest buy date. In many instances, that first-in-first-out setting helps reduce capital gains taxes, but in many times it does not. To override the default system and choose specific lots to sell, Robinhood users must email customer service and provide six different datapoints indicating the specific lot or lots they wish to sell within the two-day window after a sell order is executed but before it’s settled.

A Robinhood spokesperson told the WSJ that users have been waiting up to 30 days just for Robinhood to confirm each tax lot allocation on a case-by-case basis. The spokesperson said Robinhood is always looking for ways to improve its user experience, but there are no plans to change its tax lot allocation process at this time.

Former hedge fund manager Whitney Tilson said he was “stunned” to read that Robinhood users were missing out on this critical tax savings technique.

“Let me be clear: If you’re trading in a taxable account via Robinhood or any other app with this bug, you’re likely making a very expensive mistake!” Tilson said.

Benzinga’s Take: Earning capital gains is hard enough in the first place without overpaying on your capital gains taxes. If you use Robinhood or another one of the popular trading apps that makes tax lot allocation difficult or impossible, you’re likely coughing up a lot more of your stock market profits to Uncle Sam than other investors did in 2020.

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