What Is Cost Basis?

Are you thinking about selling an investment? If so, it’s important to remember that there are typically tax consequences involved.₁ After you sell an investment, you’ll need to determine if you’re required to claim a loss or report a gain. And to determine exactly how much that loss or gain is, you’ll need to know the cost basis of the investment that you’re selling.

Your cost basis is the value of your investment at the time that you purchased it. It includes any fees or commissions associated with the initial investment purchase.

Capital Gains and Losses

Let’s review a couple of quick examples of capital gains and losses to help illustrate the importance of knowing your cost basis.

Capital Gain Example

We’ll start with capital gains. Let’s say that your cost basis is $1,500 (100 shares at $15 a piece) and that you’re looking to sell at $2,000 (100 shares at $20 a piece) a couple of years later. You would have a capital gain of $500, which is considered as taxable income.

Many investors will have a capital gains tax of 15% or 20% for investments they hold for at least one year. A capital gains tax will only be 0% if your income is less than $47,025 as a single filer or $94,050 if you’re married and filing jointly.₂ For single filers with taxable income of $518,900 or above ($583,750 if you’re married filing jointly), the capital gains rate will be 20%.

Capital Loss Example

Let’s keep this simple and flip flop the cost basis and selling price for the capital loss example. Subtracting your selling price ($1,500) from your cost basis ($2,000) would result in a $500 capital loss, which can be used to help offset any capital gains.

Those examples might seem straightforward, but determining your cost basis and calculating capital gains and losses isn’t always so simple. Let’s explain.

Reinvested Dividends

Cost basis is also referred to as tax basis. It’s important to determine your basis correctly to help with managing your tax obligations over your lifetime.

Let’s say that instead of taking earnings in cash that you reinvest your dividends. The dividend reinvestment would result in more shares being acquired that have a different basis per share.

Stock Splitting

It’s also important to understand how a stock split impacts cost basis. A stock split will also impact your basis per share. However, it won’t affect the value of your investment. Let’s say you have a 2:1 stock split and your original investment is still $1,500. Instead of 100 shares at $15 apiece, you would have 200 shares at $7.50 apiece. There are two ways to determine your basis per share.

One option is to take your previous cost basis per share ($15) and divide it by the split factor (2:1). That gives you a new basis per share of $7.50

The other option is to take the original investment amount and divide it by the number of shares. Dividing $1,500 by 200 shares would give you your new basis per share of $7.50.

Understanding Cost Basis Is a Joint Responsibility

We used some simple examples for determining how to calculate cost basis, but it can be much more complex. Brokerage firms and mutual funds are both bound by law to report cost basis of shares purchases by investors.₃ But that doesn’t mean that you shouldn’t keep your own records, especially for tax purposes.

Whenever you receive a 1099-B from your brokerage firm or mutual fund, make sure to compare their calculations with yours as soon as possible. If they don’t match, contact the brokerage firm or mutual fund to remedy the issue prior to filing your tax return.

Working with a Team of Professionals

It’s important to remember that everyone can make mistakes, even with some simple cost basis calculations. Rather than running the risk of miscalculating your cost basis, it’s advisable to work with a team of professionals that works on your behalf.

There’s so much more to building your wealth than investment management. For example, taxes must be top of mind to understand your cost basis. That’s why our CPAs and CFAs both work alongside our CFP® professionals to review financial plans.

If you have any questions about calculating your cost basis and the planning considerations that we’ve reviewed, start a conversation with our team below.

Schedule a Meeting

It’s important to us that you’re making informed decisions with your money—and understanding your cost basis is a component of that. Having that understanding can breed confidence as you’re reviewing the goals you’ve laid out (or that you’re considering) within your financial plan. We’re ready to help you determine your basis and build you a plan that’s tailored to your specific goals.

Resources Mentioned in This Article

How Do Capital Gains Taxes Work?

How Do I Pay Less Taxes?

Can I Beat the Market?

Taxes on Retirement Income

DIY Retirement Planning: What Can Be Overlooked?

Why You Need a Financial Planning Team with Jason Gordo

Components of a Complete Financial Plan with Logan DeGraeve, CFP®, AIF®

The CFP® Professional and CPA Relationship with Logan DeGraeve, CFP®, AIF® and Corey Hulstein, CPA

Other Sources

[1] https://www.finra.org/investors/insights/cost-basis-basics

[2] https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates

[3] https://www.ici.org/node/837061

Investment advisory services offered through Modern Wealth Management, LLC, a Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management a Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.