What is cost basis?
Cost basis (sometimes referred to as tax basis) is the original value of an asset for tax purposes. It is usually considered the purchase price, which is adjusted for stock splits, dividends and return of capital distributions.
Why is cost basis important?
It is important to know the cost basis of investments in taxable investment accounts (this excludes retirement accounts and Roth IRA accounts) because you will owe taxes on the investment profit when you sell the investment. You must know the cost basis of your investment to determine the taxes due.
Over the last five years or so, custodians have been required to track and report cost basis for investors. Therefore, newer investment holdings should have the cost basis reported on monthly or quarterly statements. However, investors with holdings older than this may find their custodian shows “Missing” under the cost basis section of their account statement. In this case, there is work to do!
The work generally involves creating a spreadsheet or log of each purchase date, amount, and number of shares. Keep in mind income that is reinvested into additional shares is considered a purchase. Therefore, creating cost basis generally means going back through every statement to compile a list of every transaction. However, there is some good news! Once you know the cost basis of an investment, most custodians will allow you to manually enter the historical basis, then they will track it going forward.
Cost basis can get tricky.
Cost basis is usually most difficult to determine when an investment was received as a gift. In most cases, when you receive an investment as a gift, the cost basis from the gift-giver transfers with the investment. If the gift-giver did not also turn over the historical records of the investment, it may be almost impossible to determine the cost basis. Whenever possible, work with the gift-giver to recreate cost basis. Otherwise, talk to your CPA or tax preparer before selling any investment where the cost basis is unknown. He or she can prepare a plan of action so there are no surprises at tax time.
- Written by Annie Albrecht, Worley Erhart-Graves Financial Advisors