Cost Basis Explained

What is cost basis?

Cost basis refers to the original value of an asset, such as a stock or bond, which is used to determine capital gains or losses for tax purposes when the asset is sold or disposed of. It typically includes the purchase price plus any additional costs associated with acquiring the asset, such as commissions or fees.

Why did my cost basis change?

The cost basis of a security changes with each transaction involving buying or selling. When you purchase securities, the cost basis includes the purchase price plus any associated costs, such as commissions. If you make additional purchases of the same security, each new batch of shares will have its own cost basis, and the total cost basis of your investment is the sum of all individual costs. Upon selling securities, the gain or loss is determined by subtracting the cost basis of the sold shares from the sale proceeds. Methods such as FIFO, LIFO, or specific identification may be used to determine which shares are sold, impacting the cost basis calculation. Additionally, any adjustments due to wash sales, where a security is repurchased within 30 days (before or after) of a sale at a loss, will affect the cost basis for future transactions.

Cost basis can also change for several other reasons, with corporate actions being among the most common. Here are some of the most frequent corporate actions that can affect cost basis:

Stock Splits and Reverse Splits

When a company splits its stock, the cost basis is adjusted proportionally. For example, in a 2-for-1 stock split, you receive two shares for every one you owned, and your cost basis per share is halved.

Dividends Reinvested

If you reinvest dividends to purchase additional shares, the cost basis of these new shares will be added to your original cost basis, thus affecting your total cost basis.

Corporate Actions

Events such as mergers, acquisitions, or spin-offs can affect the cost basis. For instance, if a company is acquired and shares are exchanged for those of another company, the cost basis must be adjusted according to the terms of the exchange.

Return of Capital

Sometimes, a company returns a portion of your investment to you as a return of capital. This reduces your cost basis because it's considered a partial return of your investment rather than a dividend. This can happen after a 1099 is sent, leading to a corrected tax form being issued.

Wash Sales

If you sell a stock at a loss and then repurchase the same or substantially identical stock within 30 days (before or after), the IRS wash sale rule requires that the loss be disallowed for tax purposes. The disallowed loss is added to the cost basis of the repurchased stock. To learn more about wash sales, please visit Understanding wash sales.

Tax Lot Accounting Methods

Different accounting methods, such as FIFO (First In, First Out) or LIFO (Last In, First Out), can impact the cost basis calculation depending on which shares are sold. To learn more about tax lot preferences, click here.