Cost Basis

Cost basis is the starting point for every investment tax calculation. It begins as the purchase price plus commissions and fees, and the difference between it and your eventual sale price is the gain or loss you report.

It does not stay fixed. Reinvested dividends are new purchases and raise your basis — a detail worth tracking, because treating the original purchase price as the basis means paying tax a second time on dividends you already paid tax on. Return-of-capital distributions lower it. On a home, capital improvements raise it while depreciation taken on a rental lowers it.

When you own shares bought at different prices, which ones you sell changes the tax bill. Brokers default to first-in, first-out, but specific identification lets you choose the highest-basis lots to minimize the gain, and mutual funds also allow an average-cost method.

Brokers are required to report basis to the IRS on shares acquired after roughly 2011, which covers most holdings. Older positions, transferred accounts, and inherited or gifted assets often arrive with no basis on file, and reconstructing it falls to you.

Inheritance resets the clock. Inherited assets generally receive a stepped-up basis equal to their value on the date of death, so decades of appreciation are never taxed. Gifted assets are the opposite — the recipient carries over the giver's original basis.