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# Cost Basis of Investments

When you sell an investment, you need to determine the amount of profit or loss. This is done by subtracting the cost of the investment from what you sold it for – the proceeds.

Often the proceeds are reported to you on a Form 1099-B, Proceeds from Broker and Barter Exchange Transactions.

However, you usually need to determine the cost of the investment on your own.

The cost basis of your investment might be what you paid for it plus any commissions or fees that you paid when you bought or sold it. But sometimes it gets more complicated

Often companies do stock splits (also known as a stock dividend), reverse stock-splits, capital distributions, or purchase other companies by issuing stock to the shareholders. A company might even do a combination of these.

The following sections expand on these different scenarios and will guide you in determining the correct cost basis of your investments.

## Simple Cost Basis Calculation

You purchase 100 shares of ABC stock for \$10 per share for a total of \$1,000.

Your stock broker charged you \$100 to complete the transaction for a total cost of \$1,100 (\$1,000 for the stock + \$100 for the commission).

Your cost basis for the 100 shares is \$1,100. Your cost basis per share is \$11 per share (\$1,100 total cost / 100 total shares).

## Stock Splits and Stock Dividends

A stock split or stock dividend occurs when a company issues additional shares to its existing shareholders.

This is often done by splitting the existing shares into multiple shares – stock split – but can also be done by issuing a number of shares based on how many shares are already owned (e.g. one new share for every 10 shares owned) – stock dividend.

This lowers the value of each share by the amount of the split or dividend. A 10 for 1 stock split replaces each share owned with 10 shares and each share is now worth 1/10th of what it was before the split.

Stock Split Example:

Continuing the Simple Cost Basis example but now there is a 10 for 1 stock split.

The cost of all the shares is still \$1,000 but instead of having only 100 shares you now have 1,000.

The total cost of your shares hasn’t changed – just the quantity.

The total cost basis is still \$1,100 (\$1,000 for the shares + \$100 commission) but the cost per share is now \$1.10 (\$1,100 cost / 1,000 shares).

## Reverse Stock Split

Just as it sounds, a reverse stock split is the opposite of a stock split.

This happens when a company decides to decrease the number of shares of stock by combining the existing shares into fewer shares.

This increases the per share value of the stock and is sometimes done to meet the requirements for being listed on a stock exchange such as the NASDAQ.

A 1 for 10 reverse stock split replaces each 10 shares owned with 1 share and each share is now worth 10 times what it was before the reverse split.

Reverse Stock Split Example:

Continuing the Simple Cost Basis example but now there is a 1 for 10 reverse stock split.

The cost of all the shares is still \$1,000 but instead of having 100 shares you now have 10.

The total cost of your shares hasn’t changed – just the quantity.

The total cost basis is still \$1,100 (\$1,000 for the shares + \$100 commission) but the cost per share is now \$110 (\$1,100 cost / 10 shares).

## Capital Distribution

A Capital Distribution is a return of capital to the owner of the company shares.

This reduces the cost basis of the shares that are owned.

If the capital distribution is so large that it would reduce your cost basis below \$0 (which isn't allowed), then the excess is capital gain.

Capital Distribution Example:

Continuing the Simple Cost Basis example but now there is capital distribution of \$5 per share.

The cost of all the shares is still \$1,000 but instead of having a cost basis for the 100 shares of \$1,100, you now have a cost basis of \$600 (\$1,100 original cost basis – \$500 (100 shares * \$5 per share) capital distribution).

The cost basis per share is now \$6 (\$600 total cost basis / 100 shares).

## Purchase of Company Using Stock

A company can use various forms of payment when it purchases another company (the "target" company).

It might pay cash to the shareholders of the target in exchange for their stock or it might give shares of its own stock in exchange for the shares of the target stock.

If cash is paid, then the shareholders have effectively sold their shares and have a capital gain or loss.

If shares of stock are used to replace the existing shares then it is just a trade of one stock for the other. In this special situation, it is not considered a taxable transaction.

What might change however is the cost basis per share of stock.

Continuing the Simple Cost Basis example but now there is a purchase of the company’s stock you own in the amount of 10 shares of the buyer’s stock for 1 share of the stock you own.

The value of what you own is still \$1,000 but instead of having only 100 shares you now have 1,000.

The total cost of your shares hasn’t changed – just the quantity.

The total cost basis is still \$1,100 (\$1,000 for the original shares purchased + \$100 commission).

The cost per share is now \$1.10 (\$1,100 cost / 1,000 shares).

## Long-term or Short-term Gains

For taxes, the main purpose of keeping track of all of this is to determine the amount of your gain or loss when you sell the investment.

But there are two parts to the equation when you sell and investment: 1) gain or loss and 2) the holding period – short-term or long-term.

When you have a transaction like those noted above (e.g. stock split) you get to keep the original purchase date regardless of when the subsequent transaction occurred.

For example, if you purchased shares of stock in January of 2010, the stock split in February of 2011 (long-term holding period), and you sold all of the stock in March of 2011, all of the stock sold would be considered as having a long-term holding period even though you only had some of the shares for a month.

## Cost Basis of Mutual Funds

The cost basis of a mutual fund is calculated the same was as with a stock.

However, if you are reinvesting dividends then it might seem a little more complicated.

The reinvested dividends are simply additional purchases of the mutual fund with a cost basis equal to the dividend amount and a purchase date of the dividend date.

The cost basis of stock or other property received as a gift is generally the same cost basis as it was for the person who made the gift.

However, there are some special circumstances.

If the value of the property when it is given to you is less than the giver's cost basis, your cost basis is going to depend on whether you have a gain or a loss when you sell it.

• If, when you go to sell it,  you have a gain over the original owner's cost basis, then your cost basis is the same as the giver's cost basis.
• If, when you go to sell it,  you have a loss from the original owner's cost basis, then your cost basis is the value when you received the gift.
• If the value is greater than the giver's cost basis but less than the value when you received the gift then you don't have a gain or a loss.