Cost Basis: What Is It and Why Should You Care
With another tax season behind us, I hope you’re enjoying taking a little breather following the stresses that April can bring. I am sure that many of you have promised yourself not to leave it all to the last minute, in the future. And, while I hope you’re enjoying the fact that another tax season is 11 months away, let’s work together to make good on your promise to yourself. Let’s start thinking about making future tax seasons easier…starting with something called Cost Basis.
Here’s why you care. As you consider various investments in 2017, the Cost Basis is what will determine how you’re taxed on those investments. I’ve had clients who haven’t kept track of their Cost Basis and it can be an overwhelming problem to solve at tax time.
The Cost Basis is the purchase price for an investment (what you paid) adjusted for any stock splits, dividends, or capital distributions, (what you earned). It is critical that you record (or the custodian who holds your investments) what your purchase price is so that your Cost Basis is properly calculated. If you don’t have record of your buying price plus investments, you could be taxed on the gross profit of the stock sale, not just the net profit. If you get taxed on the whole thing, what started out as an investment ends up being a huge drain on your income and essentially you are double taxed.
Think of Cost Basis like a parking swipe card in a public parking lot. If you lose the parking swipe card, you’re going to have to pay for the whole day because no one will know when you arrived, they only know when you’re leaving. Because you know that there will be a huge penalty if you lose your card, you take extra steps to ensure that you don’t! It’s the same thing with your investments. Don’t lose the records or else you could end up paying much, much more than you need to!
What about a stock that you inherit instead of purchase? When you inherit an investment, the cost basis is whatever the value was on the date of death. For example, if you inherited a stock portfolio that was worth 100k on the date of death but the deceased (the original owner) purchased the stocks for 10K, the cost basis is re-calibrated for you to reflect the price on the day of death, not the original purchase. So, your Cost Basis is 100K, not the 10K that the deceased had.
Here’s the thing…if it’s just one stock, it’s pretty easy to keep track, but if you’re cashing out of a portfolio of many investments as a part of your strategy, you could have dozens of stocks that you purchased over the years. This ends up being a huge project to piece together each individual buying price decades later. It’s easier to stay organized along the way and give your tax accountant all of the information they need well in advance of tax time.