Tax Basis
In determining what profit an investor must include on their tax return, the IRS requires them to first calculate their tax basis (also known as cost basis) on the investment. The tax basis is the starting value (the price you paid) that an investment’s profit or loss must be measured against, as adjusted for things like commissions, stock splits, etc., which can raise or lower the tax basis.
Calculating Basis
Prior to selling a security, investors have to choose a default method of determining basis. There’s LIFO (last in, first out), HIFO (highest in, first out), LCFO (lowest cost, first out) and more … but if an investor doesn’t pick a method, then the broker-dealer must use the FIFO (first in, first out) method. FIFO uses the earliest acquired shares first.
Broker-dealers give customers cost basis information on the trade confirmation and on statements. Also, each year firms must provide customers and the IRS with cost basis information on Form 1099-B, and firms must indicate whether a capital gain is short-term (one year or less) or long-term (more than a year).
If someone purchases a stock at different times and prices, the IRS allows the individual to use the specific cost of each share when calculating capital gains. In the specific identification method, the investor can identify the shares sold by using the CUSIP number. CUSIP stands for Committee on Uniform Security Identification Procedures. A CUSIP is a unique nine-digit alphanumeric identifier for most North American securities.
If the specific cost information is not available, then the government requires the FIFO method of cost basis determination. If an investor has no cost basis information, the IRS requires the taxpayer to report a zero cost basis. And pay tax on any gain.
Two important cost basis facts:
- Cost basis includes any reinvestments of dividends or distributions, as well as any commissions or other transaction costs.
- The cost basis of inherited securities is the value of the s