6.3.2. Cost Basis and Adjusted Cost Basis
To determine the taxable gains or losses on an investment, the IRS requires taxpayers to first calculate the tax basis (also known as cost basis) on their investment. The tax basis or cost basis is the starting value (the price you paid) that an investment’s profit or loss must be measured against, as adjusted for expenses such as commissions and stock splits. Cost basis quite simply is the buyer’s cost of purchasing an asset.
Adjusted cost basis is the cost basis of the asset (purchase price) increased by accretion or decreased by amortization as the investor continues to hold the bond over time. Put another way, adjusted cost basis is the cost of owning a bond after adjusting for the change in its value over time. The holding period is the amount of time the investor owns the bonds. The formula for determining adjusted cost basis is below:
The adjusted cost basis is applied for tax purposes to determine the amount of an investor’s capital gains or losses when the investor sells a security. For bonds issued at par, capital gains or losses are the difference between adjusted cost basis and the sale price of the bond.
For tax purposes, the issue price of a bond issued at par is also known as its book value. When bonds are issued at face value, book value does not ch