Final answer:
A taxpayer may use the specific identification method for stock basis when they can identify the exact shares being sold, have records of each share's cost basis, and communicate this information to their broker. This contrasts with the FIFO method, which defaults to selling the oldest shares first.
Step-by-step explanation:
A taxpayer can use the specific identification method for determining the tax basis of stock being sold when they can adequately identify the particular shares being sold. This method allows the taxpayer to decide which shares to sell based on their individual cost basis, which can be different because of multiple purchases over time at different prices. To use this method, the taxpayer should have meticulous records that specify the date, amount, and cost of each share. The share's purchase date and cost basis must be communicated to the brokerage executing the sale, usually at the time of the transaction.
On the other hand, the FIFO (First-In, First-Out) method assumes that the oldest shares (those acquired first) are sold first. The specific identification method can be advantageous for tax purposes because it can minimize taxable gains depending on which shares the taxpayer opts to sell. However, if the taxpayer cannot specifically identify the shares or does not inform their broker in time, the FIFO method may be used by default.