Cost Basis
The original value of an asset for tax purposes, typically the purchase price plus commissions and fees, used to calculate capital gains or losses when the asset is sold.
Cost basis is the starting point for every capital gain or loss calculation. When you sell a capital asset, the IRS requires you to subtract your cost basis from the sale proceeds to determine whether you realized a gain or a loss. An accurate basis means you pay no more tax than legally required; an understated basis — common when investors lose records — can result in overpaying taxes on what should be a return of capital.
For most straightforward stock purchases, cost basis equals the total amount paid, including brokerage commissions and transaction fees. If you buy 100 shares at $50 per share and pay a $7 commission, your basis is $5,007, not $5,000. This may seem trivial, but on large or frequently traded positions it can make a meaningful difference.
Basis can be adjusted upward or downward by various events. Stock splits reduce basis per share but increase share count, leaving total basis unchanged. Dividend reinvestment plans (DRIPs) add to basis because each reinvested dividend purchases new shares. Return-of-capital distributions reduce basis, and if they push basis below zero, the excess becomes a capital gain. Corporate spin-offs require allocating the original basis between the parent and the new entity according to IRS-approved ratios.
When you own multiple lots of the same security bought at different prices, you must choose a cost basis accounting method: FIFO (first in, first out), specific identification, or average cost (allowed for mutual funds and certain ETFs). The choice can significantly affect the size and character — short-term versus long-term — of the gain or loss recognized.
Brokers are required to track and report adjusted basis to both investors and the IRS on Form 1099-B for 'covered' securities — those acquired after mandatory tracking rules took effect (generally 2011 for stocks, 2012 for mutual funds, 2014 for most fixed-income securities). For 'noncovered' securities, investors must maintain their own records. Keeping thorough purchase records, including confirmation statements and DRIP statements, protects you from overstating gains in the absence of broker data.