In 2008 good old George Jr. passed the bail out bill which led to the new cost basis legislation being rolled out in 2011. The purpose of the new cost basis legislation was to tax the billions of dollars a year of unreported income resulting from people improperly calculating cost basis. It may just seems like something the IRS wanted to do so we would bang our heads against the wall even harder during tax season, but those pennies began to add up and they took notice.
The new regulations require brokers to start reporting cost basis on IRS form 1099-B for stocks acquired after January 1, 2011. In 2012 they will be required to report cost basis on mutual funds followed in 2013 by bonds. The problems arises on all of the uncovered securities that were purchased prior to these dates. Thus we have the cost basis dilemma and you reading this article.
Learning how to calculate cost basis when selling a security can be difficult due to the number of corporate actions such as mergers, dividends, and spin offs that occur over a companies history. Usually the longer you have owned a security the larger of a cost basis headache you will have. However you’re in good luck as I consider myself to be a cost basis guru and will teach you how to easily calculate cost basis to keep Uncle Same from knocking on your door.
Cost basis of an investment is the original value of an investment adjusted for things like splits, dividends, mergers, and capital contributions. More simply put, cost basis is the total capital you put in an investment plus any commission involved in the acquisition. This can become difficult due to all of the corporate actions that can take place over time or if you inherit an investment. Uncle Sam wants to make sure you are being a good citizen and calculate this appropriately so he can keep buying his fancy hats.
Calculating Cost Basis the Hard Way
I know, I just told you I would teach you how to calculate cost basis the easy way. However, I want to make sure I covered how to manually calculate cost basis for those of you who like to crunch numbers or are maybe just interested in cost basis. If you’re not one of those people skip to the next section.
- Gather all the statements you can find. The more information you have the better off you will be.
- Determine your initial investment by adding your capital contribution plus any commissions. For example, if you purchased 10 shares of XYZ at $10 per share and paid $10 dollars in commission, your cost basis would be $110 or $11 dollars per share.
- Next you need to account for any corporate actions or events that took place that altered your basis such as dividends, splits, and so on. If you reinvested your dividends you would need to add this to your cost basis calculated in step 2. If a stock split occurred where you received 2 shares for ever share you own the new cost basis per share for the example in step 2 would be $5.50.
- Follow the same steps for any additional acquisitions you have made and calculate your new cost basis. For example, lets assume you purchased another 10 shares of XYZ at $20 per share and paid $20 in commission. Your cost basis on this transaction would be $220 or $22 per share. Now combine your basis from step two and your new cost basis would be $330 or $16.50 per share.
- Continue these steps until you have accounted for all of your acquisitions.
- If you have sold any of your investment during your holding you will have to factor this into your cost basis as well. Generally most people use the FIFO method when selling an investment but you will have to check with your broker.
Calculating Cost Basis the Easy Way
There are a number of companies out their that offer cost basis solutions like Gainskeeper and Netbasis. Their applications are web based and very user friendly along with there customer support. With cost basis software you can calculate some of the most complex calculations in a matter of seconds including: Gifting, Date of Death, Wash Sales, Fair Market Value, Non-Covered and Compensation Related Equity Shares.
One of the powerful features of Netbasis that is very useful is it’s power search. Power search allows you to unwind a security back to your original purchase date. If you can’t remember what you originally acquired the power search feature will allow you to input your initial acquisition date and the values from a current statement to calculate your cost basis.
Some cost basis calculations can take hours upon hours to do by hand and others can be done in a few minutes. Odds are that if you purchased your security a long time ago you will want to use a cost basis software solution. Even simple transactions can be worth double checking to help avoid an audit from the IRS. Your personal accountant may also be able to provide some insight for you but from my experience most of them consider calculating cost basis the tax payer and brokers job. If I was you I would keep Uncle Sam away by calculating cost basis the easy way.