Cost Basis

Cost basis is generally the amount paid to acquire an investment or other property, including specified acquisition costs, before later adjustments. Its adjusted basis is used with the amount realized on a sale or other disposition to calculate gain or loss for tax purposes. Basis rules depend on the asset, transaction, jurisdiction, and taxpayer, so a brokerage display is useful evidence but not always the final tax answer.

Key Takeaways

• Purchase price plus eligible acquisition costs is a common starting point, but some property receives a basis determined under gift, inheritance, exchange, or other special rules.
• Stock splits reallocate existing basis across more or fewer shares; they do not normally create new total basis by themselves.
• Reinvested distributions purchase new shares with their own basis, while a nondividend return of capital generally reduces existing basis under U.S. federal tax rules.
• Investors must identify which tax lot was sold. Specific identification and FIFO are common; average basis is available only for specified eligible holdings and elections.
• A general LIFO election is not an IRS cost-basis method for ordinary stock and bond sales.
• Gifted property can have different gain and loss bases, and inherited-property basis has exceptions to the familiar date-of-death fair-value rule.
• Taxpayers remain responsible for accurate basis even when a broker reports an amount on Form 1099-B.

Basic Gain or Loss Formula

For a taxable disposition, the simplified relationship is:

The amount realized can differ from gross sale proceeds because selling costs, liabilities assumed by a buyer, cash received, and noncash consideration can matter. The adjusted basis must correspond to the exact property or tax lot disposed of.

This formula calculates a gain or loss amount, not the tax due. Holding period, character, loss limitations, exclusions, tax rates, and jurisdictional rules are separate questions.

Cost Basis vs. Adjusted Basis

Tax basis, accounting carrying amount, and fair market value can all differ for the same asset. They should not be substituted for one another without a rule that requires it.

What Can Change Basis?

The following U.S. examples illustrate common adjustments. They are not a complete list.

Cash dividends paid from earnings generally do not reduce stock basis merely because they are dividends. If a dividend is reinvested, however, the reinvested amount buys additional shares and creates basis in those shares. The distribution’s tax character under applicable rules, as reported or later corrected by the issuer, matters more than the label shown in a portfolio app.

Tax-Lot Identification Methods

When identical securities were acquired in several lots, the investor must determine which lot was sold.

Specific Identification

Specific identification uses the adjusted basis of the particular shares selected. Under the U.S. rules described in IRS Publication 550, the investor generally specifies the shares to the broker or agent at the time of sale or transfer and receives written confirmation within a reasonable time. Records should preserve the acquisition date, quantity, basis, and confirmation.

Specific identification can change the timing and character of gains and losses, but selecting the highest-basis lot does not automatically minimize lifetime tax. Holding period, wash sales, loss limitations, portfolio exposure, and future plans also matter.

First-In, First-Out

If shares cannot be adequately identified, U.S. federal rules generally treat the earliest acquired shares as sold first. FIFO is therefore more than a convenient spreadsheet assumption when identification fails.

Average Basis

Average basis is not a universal method for every security. IRS Publication 550 permits it for specified mutual fund or other regulated investment company shares and certain dividend-reinvestment-plan shares when the requirements and election rules are met. The election can affect later lots and may have revocation limits.

Why LIFO Was Removed From This Page

Last-in, first-out is an inventory accounting convention and may also be a broker interface preference in some contexts, but it is not a general U.S. federal tax-basis method for ordinary sales of stocks and bonds. A taxpayer should not assume that selecting “LIFO” in an interface produces valid specific identification without timely instructions and confirmation.

Worked Example: Split, Return of Capital, and Sale

Assume an investor:

1. buys 100 shares for 40 each and pays a 5 acquisition commission;
2. receives a 2-for-1 stock split;
3. later receives a 100 distribution correctly classified as a nondividend return of capital; and
4. sells 80 shares for 30 each, paying an 8 selling commission.

Step 1: Initial Basis

Step 2: Allocate Basis After the Split

The investor now owns 200 shares. Total basis remains 4,005:

Step 3: Reduce Basis for Return of Capital

The adjusted basis is 19.525 per share.

Step 4: Calculate the Sale

The remaining 120 shares retain 2,343 of basis. This example assumes one original lot, a nontaxable split, a valid 100 nondividend distribution, no wash sale, and no other adjustment. It does not calculate tax.

Gifts and Inherited Property

Basis other than cost often needs professional review.

Gifted Property

Gifted property does not always have a single carryover basis. Under U.S. federal rules, if fair market value at the gift date is below the donor’s adjusted basis, the recipient can have one basis for determining gain and another for determining loss. A sale price between those amounts can produce neither gain nor loss. Gift tax paid can also affect basis in specified circumstances.

Inherited Property

Inherited property generally uses fair market value at the decedent’s death, an elected alternate valuation amount, or another applicable estate-tax value. Exceptions include specified special-use property, conservation-easement adjustments, consistent-basis requirements, and certain appreciated property transferred to the decedent shortly before death. “Inherited assets always receive a step-up” is therefore too broad.

Broker Reporting and Recordkeeping

A broker may report basis to the taxpayer and IRS for covered securities. Noncovered Securities can appear without broker-reported basis, and reported basis may omit events outside the account.

Records should include:

• trade confirmations and acquisition fees;
• reinvested distributions and return-of-capital notices;
• stock splits, mergers, spinoffs, tenders, and reorganizations;
• gifts, inheritance values, and transfer statements;
• wash-sale adjustments, including relevant activity at other brokers;
• depreciation, improvements, casualty adjustments, and prior tax returns; and
• lot-selection instructions and confirmations.

Account transfers can lose historical detail. Compare incoming basis and acquisition dates with original records before relying on the new broker display.

Common Mistakes

• Using purchase price without fees: Eligible acquisition costs can change initial basis.
• Treating reinvested dividends as free shares: The reinvested amount generally creates basis in the new shares.
• Reducing basis for every dividend: Ordinary or qualified dividend status differs from a nondividend return of capital.
• Using LIFO as a default tax method: Ordinary securities generally require adequate specific identification or FIFO, with average basis limited to eligible holdings.
• Averaging ordinary stock lots without authority: A portfolio’s average purchase price is not necessarily its tax basis method.
• Ignoring wash sales across accounts: Broker reporting may not capture every relevant purchase by the taxpayer or related accounts.
• Assuming gift basis always equals donor basis: Dual gain-and-loss basis rules can apply when gift-date value is lower.
• Assuming every inheritance receives a simple step-up: Valuation elections, exceptions, and consistency rules can change the result.
• Equating basis with market value or book value: Each amount answers a different question.
• Assuming reported basis is final: The taxpayer remains responsible for adjustments and supporting records.

Authoritative Sources

• IRS Publication 550, Investment Income and Expenses covers basis for stocks, bonds, mutual funds, tax-lot identification, FIFO, average basis, reinvested distributions, stock splits, returns of capital, and wash sales.
• IRS Publication 551, Basis of Assets covers cost and adjusted basis, improvements, depreciation, gifts, inherited property, exchanges, and other basis rules.
• IRS Instructions for Form 8949 explain reporting of capital-asset dispositions and basis adjustments.

Related Terms

• Adjusted Tax Basis: Starting basis after required increases and decreases.
• Capital Gain: Gain whose tax treatment depends on the asset, holding period, transaction, and applicable rules.
• Wash Sale Rule: U.S. loss-deferral rule that can transfer a disallowed loss into replacement-property basis.
• Return of Capital: Distribution classification that generally reduces basis before producing gain under U.S. rules.
• Stock Split: Corporate action that changes share count and reallocates per-share basis.
• Capitalized Interest: Eligible borrowing cost added to a qualifying asset under financial-reporting rules.

FAQs

This article provides general U.S. federal tax education, not individualized tax, legal, accounting, or investment advice. Rules change and other jurisdictions use different systems; verify current official guidance for an actual transaction.