The cost basis of an asset is important because it determines how much profit or loss is realized when the asset is sold. So what is cost basis?
What Is Cost Basis?
According to the cost basis definition, the cost basis is the original value of an asset for tax purposes.
The cost basis is used to determine the capital gain or loss when the asset is sold.
Stocks
The cost basis for stocks is the original price paid for the shares, plus any commissions or fees.
This is important to know because it determines how much profit or loss is realized when the shares are sold.
The cost basis can be adjusted for stock splits, dividends, and other corporate actions. For tax purposes, the cost basis is used to calculate capital gains or losses.
Mutual Funds
When it comes to mutual funds, the cost basis is the original value of your investment, plus any reinvested dividends and capital gains.
This number is important because it's used to calculate your realized and unrealized gains (or losses).
Inherited Assets
The cost basis for inherited assets is the original value of the asset at the time it was purchased by the original owner.
When an asset is inherited, its cost basis is "stepped up" to its current market value.
This means that if the asset has appreciated in value since it was purchased, the inheritor will not have to pay capital gains tax on any appreciation that occurred before they inherited the asset.
The stepped-up cost basis only applies to assets that are held in a decedent's name at the time of their death; it does not apply to assets that are transferred to an inheritor during the decedent's lifetime.
Average Cost Basis
An average cost basis is the average price of a security or group of securities over time. It's used to calculate gains or losses for tax purposes when the security is sold.
The calculation is relatively simple: add up all your purchase prices and divide by the number of shares you own.
How To Calculate Cost Basis?
Wondering how to calculate cost basis?
There are a few different ways to calculate cost basis, and the method you use will depend on the type of security you're dealing with.
Dependence On Security Type
- Stocks and mutual funds can be bought and sold through brokerages, so your cost basis is generally the price you paid for the shares, plus any commissions or fees.
- With bonds, you may have to factor in accrual dates and interest payments.
- And if you're calculating the cost basis of real estate, there are a number of factors to consider, such as purchase price, closing costs, renovation costs, and more.
Gather Basic Information
To get started, you'll need to gather some basic information about your asset purchases.
This includes the date of purchase, the purchase price (including any commissions or fees), and any subsequent sales prices (again, including any commissions or fees).
Adjustments
If you've held the asset for more than one year, you'll also need to know the original cost basis - which is usually the purchase price - and the adjusted cost basis, which takes into account things like stock splits or reinvested dividends.
Once you have all of this information gathered, there are a few different formulas you can use to calculate your cost basis.
Formula
The cost basis formula is a mathematical equation used to calculate the original value of an investment.
It takes into account the purchase price of the investment, any commissions or fees paid, and any reinvested dividends or capital gains.
Example
For example, if you bought 100 shares of stock for $10 per share and paid a $5 commission, your cost basis would be $1,005 ($10 x 100 + $5).
If you then sold the stock for $15 per share, your capital gain would be $495 ($15 - $10 per share x 100 - $5 commission).
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