Cost Basis

Cost basis is the original amount paid for an investment or asset, adjusted for stock splits, dividends, commissions, and return of capital distributions. When you sell an asset, your taxable gain or loss is determined by the difference between the sale price and your cost basis.

For stocks purchased at different times and prices, several methods can be used to determine cost basis: specific identification (choosing which shares to sell), first-in-first-out (FIFO), last-in-first-out (LIFO), and average cost. The method chosen can significantly impact your tax liability. For example, selling your highest-cost shares first minimizes capital gains taxes in the current year.

Accurate cost basis tracking is crucial for tax compliance and tax-efficient investing. Brokerage firms are required to report cost basis to the IRS for most securities purchased after specific dates. For inherited assets, the cost basis is generally stepped up to the fair market value at the date of death, which can eliminate capital gains taxes on decades of appreciation.