Standard on all M1 accounts is the Tax Minimization feature, which we believe can be more useful to our customers than Tax Loss Harvesting features found at other companies.
Tax Minimization uses a lot allocation strategy when selling securities to help reduce the amount owed on taxes automatically.
Whenever a security is sold, that transaction creates a taxable event. There are many factors that affect how the sale is taxed, but a very important one is the net gain or loss on the holding. In other words, the amount of taxes owed will largely depend on how much the security has increased or decreased from the cost basis, the original price a customer paid to buy the security.
A customer will typically accumulate more than one share of a security over time at different cost bases. As such, when it comes time to sell some shares of a security, the specific portion of the holdings that gets sold can have a material impact on taxes owed. Another factor impacting how your sale is taxed is whether the gains are considered short-term or long-term.
Many brokerages take a simple “first in, first out” (FIFO) approach to this problem. The shares that were first purchased are also the first to be sold. While this may appear to be a sensible approach, simply selling via FIFO may not be the most tax efficient sale strategy since stock prices can fluctuate quite frequently. M1 has created the Tax Minimization feature to be as efficient as possible and help reduce customer tax liability.
When shares are bought or sold together, that bundle of shares is called a lot. With Tax Minimization, when selling some of your shares, M1 begins by looking at the lots of a given position that may result in a loss or zero gain. Selling these would not reduce the overall dollar quantity from the sale but could eliminate your tax liability on this particular sale.
Secondly, for lots that indeed resulted in gains, we sell the lots that would result in being taxed at long-term capital gains, which has a lower rate than short-term capital gains.
Finally, if more shares still need to be liquidated, the last type of lots we would sell are those that would be taxed at short-term gains.
You request a withdrawal from your M1 account.
Our algorithm determines which securities to sell, based on target allocations.
We then sell securities, prioritizing them in this order:
- Lots that do not result in a tax liability.
- Lots that result in long-term gains.
- Lots that result in short-term gains.
After executing the sale, we transfer the funds to your bank account.