Understanding The Basics Of Cost Basis

Understanding The Basics Of Cost Basis

Cost basis is defined as the original value of an asset after stock splits, dividends, and the return of capital is being adjusted. If you’re planning to sell an asset, it’s important to know about the cost basis because this is how you find out your possible capital gain or loss. Among the properties considered as an asset includes real estate properties, stocks, bonds, and other types of investments. The term Cost basis is also applicable when describing the difference between the cash price and the futures price of a commodity. It also involves any sales charges or transaction fees. If you own a taxable account, calculating the cost basis is one of the required information you need to prepare your income tax return.

As by definition, looking into your cost basis will, therefore, help minimize your tax liabilities on stock sale and reduce a possible estate tax bill. The basis is where tax related calculations and strategies start.

Cost Basis Calculation

A simple example of calculating cost basis is buying shares at $30 and $60 and then selling them at $100 per share. Whichever has the higher cost basis on the shares will result in a lower taxable gain when sold. There are several methods in calculating cost basis and most of them are so detailed that it actually results in more accurate calculations and provides the right amount of taxes paid. If you’re confused as to what method to use in calculating the basis of your assets, consult your broker or mutual fund company. Here are the three most common method use:

First in, first out (FIFO) method. The cost basis of this method is based on your oldest assets being sold first before anything else.

Specific Share Identification Method. The specific shares being sold is used to calculate the cost basis in this method.

Average Basis. Calculating the cost basis in this method is based on the average value of all of your properties or assets.

The people who calculate the cost basis, as already mentioned above, are your stockbroker or mutual fund company given that you bought your stocks after 2011 or purchased your mutual funds after 2012. The Law that states this was passed in 2008 and states to use form 1099-B when the person is selling. They are required by the IRS to calculate the cost basis and report it for tax purposes. There are those who didn’t have to deal with stockbrokers with all their investments will calculate the cost basis themselves in preparation for their taxes and keep their own records.

Accurate and Complete Record Keeping

In order to determine and prove the adjusted basis you calculated, make sure that you back it up with accurate and complete records regardless of how old those records are. An important factor in estate tax planning is the investment basis record. Presently, assets to go to your heirs when you pass or is also considered as a “stepped up” basis. It means assets are inherited at a fair market value of the assets on the day of death or the alternate valuation date.

The new tax act, however, states that estate tax has a schedule elimination on 2010. This is the time where a new carryover starts wherein the basis of the property owned by the person who died is carried over to the heir in most cases. There will be some amount of the inherited property that will qualify for tax exemption but the heir will have to present proper and accurate documentation of the remaining assets. Included in this are the assets the heirs hold on to like a family business passed down to multiple generations. When you have incomplete or inaccurate documents, problems will arise such as future disputes with the IRS and added fees to pay for Lawyers who will have to work more just to calculate basis.

You know you’re keeping good records if you’re able to keep track of the information you gathered from trade confirmations and the amount you paid for specific shares.The stock dividends or non-dividend distributions will significantly affect the result of your cost basis calculation so make sure you keep up with the information coming from them as well.

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