what is cost basis 
cost basis is the original value of an asset for tax purposes usually the purchase price adjusted for stock splits dividends and return of capital distributions this value is used to determine the capital gain which is equal to the difference between the asset s cost basis and the current market value the term can also be used to describe the difference between the cash price and the futures price of a given commodity ellen lindner investopediaunderstanding cost basisat the most basic level the cost basis of an investment is the total amount originally invested plus any commissions or fees involved in the purchase this can either be described in terms of the dollar amount of the investment or the effective per share price paid for the investment using the correct cost basis also referred to as the tax basis is important especially if you reinvested dividends and capital gains distributions instead of taking the earnings in cash reinvesting distributions increases the tax basis of your investment which you must account for to report a lower capital gain and therefore pay less tax if you don t use the higher tax basis you could end up paying taxes twice on the reinvested distributions determining the correct cost basis is also the first step when calculating gains and losses after a stock is sold reinvesting dividends increases the cost basis of a stock because dividends are used to buy more shares the average cost basis method is commonly used by investors for mutual fund tax reporting a cost basis method is reported with the brokerage firm where your assets are held many brokerage firms default to the average cost basis method investors can also choose from other methods including first in first out fifo last in first out lifo high cost low cost and more once a cost basis method is determined for a specific mutual fund it must remain in effect brokerage firms will provide investors with appropriate annual tax documentation on mutual fund sales based on their cost basis method elections the concept of cost basis is basically straightforward but it can become complicated in many ways tracking cost basis is required for tax purposes but is also needed to help track and determine investment success the key is to keep good records and simplify the investment strategy where possible example of cost basisfor example if 100 shares of a stock were purchased for 1 000 last year with the first year of dividends amounting to 100 and second year dividends amounting to 200 all of which were reinvested applicable tax law considers these reinvested earnings to be income for tax calculation purposes the adjusted cost basis when the stock is sold will be recorded at 1 300 instead of the original purchase price of 1 000 thus if the sale price is 1 500 the taxable gain would only be 200 1 500 1 300 instead of 500 1 500 1 000 if the cost basis is incorrectly recorded as 1 000 this results in a higher tax liability than would normally be due cost basis comparisonscost basis comparison can be an important consideration assume that an investor made the following consecutive fund purchases in a taxable account 1 500 shares at 20 1 000 shares at 10 and 1 250 shares at 8 the investor s average cost basis is calculated by dividing 50 000 by 3 750 shares the average cost is 13 33 suppose the investor then sells 1 000 shares of the fund at 19 the investor would have a capital gain of 5 670 using the average cost basis method results can vary significantly by cost basis in this case the investor would be better off if they had selected the fifo method or the high cost method to determine the cost basis before selling the shares these methods would result in no tax on a loss of 1 000 with the average cost basis method the investor must pay a capital gains tax on the gain of 5 670 