Understanding Cost Basis (2024)

FAQs

How do you understand cost basis? ›

Cost basis is the original value of an asset for tax purposes—usually the purchase price, adjusted for stock splits, dividends, and return of capital distributions. This value is used to determine the capital gain, which is equal to the difference between the asset's cost basis and the current market value.

If your true cost basis is unclear, please consult a financial advisor, accountant or tax lawyer. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.

First-in, first-out method (FIFO)

This is the default for all investments other than mutual funds. Method implications: Because asset prices tend to rise over time, using FIFO as your cost basis method will have the oldest shares sold first, and those shares will often have the lowest cost basis.

Bottom Line. To verify the cost basis of a capital asset, you will typically need either original documents, third party evidence or published market data. The details will depend on the specific assets involved, and can get particularly complicated when you're stepping up inherited assets.

Some investors believe that when they reinvest dividends or capital gains—meaning they use the proceeds to buy more shares of the investment—that distribution becomes part of their investment return. But here's what really happens: When the distribution is reinvested, it's added to your cost basis.

In its broadest sense, cost basis refers to the price you paid for your shares. That figure is adjusted upward for reinvested dividends and capital gains and any commissions or transaction fees you paid. What cost basis won't necessarily tell you is how much money you made on an investment.

If the cost basis information that is reported on your Form 1099-B is incorrect, you can report a correction to the IRS using Form 8949.

Cost Basis Reduction

The only way to reduce our cost basis is to limit profitability. By limiting profitability, we increase our probability of success. Reducing cost basis continually in long stock positions, allows us to generate capital and improve our probability of success in sideways markets.

In this case, you should refer to the original brokerage statement detailing the purchase of that security or contact your former broker to determine the Date Acquired and Cost Basis (what you paid for the security) and enter it manually into your tax preparation software or onto your Form 8949.

Set your preferred cost basis method

If you don't, when you sell shares of that investment, you'll have to pick a method before you can complete the transaction. Even if you've already selected—and even used—one of these cost basis calculation methods, you can change it for future sales whenever you want.

What is the average cost basis of capital gains? ›

The average cost basis method considers the total cost of your investment, factoring in purchases, reinvested dividends, capital gains and returns of capital. From that figure, it calculates the average purchase price of your shares.

Cost basis is simply the original value, or purchase price, of an asset for tax purposes. It is adjusted along the way for reinvested dividends and capital gains, and return of capital distributions that are all taxed in the year they occur.

The bottom line is that the IRS expects you to maintain records that identify the cost basis of your securities. If you don't have adequate records, you might have to rely on the cost basis that your brokerage firm reports—or you may be required to treat the cost basis as zero, which could mean owing more in taxes.

Expenses to fix up a home for sale, such as a fresh coast of paint, cannot be deducted from the sales proceeds, nor can they be added to basis, says Gray. For rental properties, the cost basis rules are similar to those for residences.

Evaluating your property's worth

In order to calculate cost basis, you use either the value of the property on the date of the original owner's death or a date selected by the executor no later than six months after the death.

At a very basic level, the cost basis is the cost of your small business. The basis calculation consists of your financial contributions to the company plus ordinary income and losses minus distributions (like dividends and other payouts).

Highest in, first out (HIFO) is a method of accounting for a firm's inventories wherein the highest cost items are the first to be taken out of stock. HIFO inventory helps a company decrease their taxable income since it will realize the highest cost of goods sold.

Cost basis represents the initial value of a security or mutual fund that an investor owns. The average cost is calculated by dividing the total amount in dollars invested in a mutual fund position by the number of shares owned.