What Is Cost Basis and Why Does It Matter?
Cost basis determines how much gain you report when you sell an asset. Getting it wrong can mean overpaying taxes or triggering an audit.
Understanding Cost Basis
What Is Cost Basis?
Cost basis is what you originally paid for an asset. When you sell, your gain or loss is calculated as: Sale Price - Cost Basis = Gain (or Loss).
Why It Matters
If you don't track basis correctly, you may:
- Overpay taxes (paying on gains that don't actually exist)
- Underpay taxes (and face IRS issues later)
Stocks and Investments
Original basis = Purchase price + Commissions
Adjustments to basis:
- Reinvested dividends: Add to basis
- Stock splits: Divide basis among new shares
- Return of capital distributions: Reduce basis
Cost Basis Methods for Stocks
- FIFO (First In, First Out): Assume oldest shares sold first
- Specific Identification: Choose which lot to sell (can minimize taxes)
- Average Cost: Average price of all shares (for mutual funds)
Real Estate Basis
Starting basis = Purchase price + Closing costs + Transfer taxes
Additions: Capital improvements made during ownership
Reductions: Depreciation claimed (if rental property)
Inherited Assets
Stepped-up basis = Fair market value at date of death. This eliminates all capital gains accrued during the deceased's lifetime.
Gifted Assets
Receive the donor's original basis ("carryover basis") unless the FMV at gift was lower.
Selling assets? Proper basis tracking is essential for accurate tax reporting.