Cost basis

Your cost basis is the adjusted purchase price of an investment, used to calculate your capital gain when you sell. The amount you paid for an asset minus any adjustments (dividends, splits, return of capital) is the starting point; the difference between your sale price and your cost basis is your taxable gain. The method you use to calculate basis can make a six-figure difference in your tax bill.

How basis works

When you buy a stock for $100 and sell it for $150, your capital gain is $50. That $100 purchase price is your cost basis. If you bought it for $100 and sell it for $80, your loss is $20.

Cost basis is not static. If you buy a stock for $100 and it pays a $10 dividend that you reinvest, your new basis becomes $110 (assuming the dividend was not a return of capital). If the stock splits 2-for-1, your basis per share is halved. These adjustments keep your basis aligned with economic reality.

Adjustments to basis

Several events increase or decrease your cost basis:

Reinvested dividends. When you reinvest dividend payments to buy more shares, your basis in those new shares is the dividend amount you paid; and your basis in your original shares is unchanged.

Stock splits. If a stock splits 2-for-1, your basis per share is halved (but your total basis in the position remains the same).

Return of capital. Some distributions, especially from REITs or natural resource partnerships, are not dividends but returns of your capital. These reduce your cost basis; if the return exceeds your basis, the excess is a capital gain.

Stock dividends. If you receive new shares as a dividend (rare), your basis is adjusted across all your shares.

Merger or reorganization. If your holding is acquired or merged, your basis typically carries forward (carryover basis).

Choosing a method

When you own multiple lots of the same stock at different prices—bought at $50, then at $80, then at $120—selling triggers a question: which lot am I selling? The answer determines your gain.

• Specific identification. You explicitly choose which lot to sell, usually the highest-cost one (to minimize gain). This requires broker instruction and documentation.
• FIFO (First In, First Out). You are deemed to sell the oldest lot first. Often the worst choice if you bought at lower prices long ago.
• LIFO (Last In, First Out). You are deemed to sell the newest lot first. Useful if recent purchases were at higher prices.
• Average cost. You average all your costs across all lots and sell at that average. Simple but not always tax-optimal.

Most brokers default to FIFO, which is often not tax-efficient. The IRS requires you to specify your method, and you must use it consistently for a given stock. Switching methods requires IRS approval.

Importance of documentation

Your broker tracks your cost basis and reports it to the IRS on Form 8949. For securities acquired after 2011 in a US account, brokers are required to report your basis. For older securities or inherited accounts, you may need to provide your own cost basis documentation. Keep records of all purchases, dividends, and adjustments.

Inherited basis: step-up

When you inherit an investment, you do not take on the decedent’s cost basis. Instead, you receive a step-up in basis—your new basis is the fair market value on the date of death. This is an enormous tax advantage: if someone held a stock worth $1,000 that had cost them $100, you inherit it at a $1,000 basis, erasing all embedded gains. You could sell it immediately with no tax.

Recordkeeping and life events

Cost basis tracking is critical. Use your broker’s cost-basis reports; do not guess. If you transfer an account or change brokers, confirm that your cost basis transfers accurately. If you sell an inherited asset, confirm you used the stepped-up basis, not the original basis.

See also