Before you start investing there are some basic concepts that you should be able to understand such as dollar-cost averaging, order types, etc. One of the most basic things any investor should be able to do is correctly calculate their profits.
So when it gets to the end of the fiscal year they know exactly how much they will be paying tax on. In this blog post, we will take a look at the formal method used by the Revenue Commissioner in Ireland to calculate the profits on your investments.
This is called the FIFO method (First In First Out). This rule really comes into play when you are disposing of only a part of your holdings in any particular share.
When you dispose of any shares according to the FIFO method you are always disposing the oldest shares you purchased first.
How Does The FIFO Rule Work?
Lets now go through some examples:
In the above example, the investor disposed of 4 shares in November. According to the FIFO rule, the investor should start with the oldest shares first when calculating the cost.
Therefore, first they take the 3 shares bought in April for €131. Also, they take 1 of the 2 shares they bought in July for €137. This leaves them with a total cost of €530 (3 shares @ €131 +1 share @€137).
The total sales proceeds from the sale were €716 and they are then left with a profit for tax purposes of €186.
In What Situations Does FIFO Not Apply?
This FIFO rule applies in all situations except:
“In the case of a disposal by a person of shares of the same class as shares which the person acquired in the 4 weeks preceding the disposal, the normal first in first out rule does not apply. Instead, the shares acquired in the 4 week period are treated as the shares actually disposed of”No.39 TCA97 Section 581
What this essentially means is that the normal FIFO rules do not apply to a situation where you have bought and sold shares within a 4 week period. Instead you must calculate the profit solely on the shares bought and sold in that 4 week period.
Lets now look at another example:
In the above example, the investor bought 2 Apple shares on the 1st of August and then sold 2 on the 15th of August which was within a four week period.
Therefore, when calculating the profit on this disposal on the 15th of August it is not against the oldest shares (1 April) but the shares they bought in this same 4 week period (1 August).
The profit calculation is the sales proceeds of €310 less the cost of €290, leaving a profit of €20.
In summary, when disposing of shares you have invested in, for the purposes of calculating your profit for tax, it is always the oldest shares you have disposed first. Unless you have bought and sold the same share class within a 4 week period.
There is another very important concept to understand as a beginner and that is the wash sale rule. Which we will cover in another post.
For more information in relation to Capital Gains Taxes in Ireland, Revenue.ie have a lot of detailed examples you can take a look at here.
This blog post is for educational purposes only and should not be construed as financial advice.