Business, Legal & Accounting Glossary
Cost basis reflects the true cost of purchasing a financial asset held over an extended period of time. The longer a stock or other asset is held, the higher the probability that the original purchase price will need to be revised in order to reflect adjustments such as future purchases, stock splits, and dividend payments. For assets purchased in several transactions, the initial cost basis is the average cost from all transactions. If a stock splits, the original cost basis is adjusted downwards. For example, in a two-for-one split, the new cost basis is the old cost basis divided by two. A reverse stock split, where the number of shares outstanding is decreased, will also increase the cost basis. Cost basis can also increase if a dividend is reinvested. In this case, the cost basis goes up to reflect the increased investment. Using an incorrect cost basis can have significant tax implications as it affects the calculation of taxable profits.
Basis (or cost basis), as used in United States tax law, is the original cost of property adjusted for factors such as depreciation. When property is sold, the difference between the sale price and basis is the income or loss reported at that time on U.S. tax returns. Basis is most commonly used in the computation of capital gains.
From Publication 551: “Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also, use it to figure gain or loss on the sale or other disposition of property.”
For federal income taxation purposes, determining basis depends on how the asset in question was acquired.
For mutual funds, there are 4 basis methods approved by the IRS, detailed in Publication 564:
Cost basis methods:
Average basis methods:
Specific share identification is the most record and labour-intensive, as one must track all purchases and sales and specify which share was sold on which date. It almost always allows the lowest tax bill, however, as one has discretion on which gains to realize.
Average cost single category is widely used by mutual funds, as it is the simplest in terms of record-keeping (only total basis need be tracked) and sale (no specifying required), and results in moderate tax.
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This glossary post was last updated: 19th April, 2020 | 4 Views.