This would leave...
This would leave a position worth $237,000 ($287,500 $50,000 or
20,000 shares at an average price of $11.88. This method corresponds
with the first in, first out (FIFO) method.
If the accountants removed the $12.50 shares:
Remove 5,000 XYZ at $12.50
Cash
$75,000
XYZ common
$62,500
Gain on sale of XYZ
$12,500
This would leave a position worth $225,000 ($287,500 $62,500 or
20,000 shares at an average price of $11.25. This method corresponds
with the last in, first out (LIFO) method.
9.5 The hedge fund will likely mark the positions to market regularly and associate the gain or loss to the investors each period. The difference between the two costs will not affect the net income, as long as this unrealized gain or loss is included in the performance. The hedge fund will report a higher realized gain and a lower unrealized gain if the $10 shares are removed instead of the $12.50 lot.
The hedge fund will report the realized gain to investors, who must include their share of the gain in their income. Taxable investors will report higher taxable income if the lower-cost lot is used. However, if the fund sells the remaining shares in the same tax year, the investors will notice no difference in taxable income. For hedge funds that buy and sell frequently, the choice of lots may not matter much.