How to Calculate Cost Basis Accurately? : NobleTrading Blog

Friday, January 9, 2009

How to Calculate Cost Basis Accurately?

For accurately calculating cost basis (and the tax you are liable) you need to know at least five things; 1) the original amount you paid for the stocks and other instruments, 2) the date of purchase, 3) commissions and other fees involved, 4) how you acquired the stocks and 5) benefits if any, usually dividends, you got by holding the stocks. Your personal trading records, brokerage and bank statements, statements on dividend reinvestment and gift/inheritance records can help you in figuring out the above things.

In normal circumstances cost basis is the total amount of investing plus commissions involved. Cost basis is usually calculated on per share basis thus it is derived by dividing the sum (invested amount + commission) with the number of shares purchased.

But many times things can get complicated.

In case of a stock split the total cost basis does not changes, but per share cost basis changes with respect to the stock split. E.g.: The total cost basis for 1000 stock purchased for $10,000 will be $10,000 and per share cost basis will be $10. For a 2:1 stock split, per share cost basis becomes $5 ($10,000/2,000 shares).
If the trader buys stocks at different prices (1000 shares for $20 and then 1000 shares for $10) and then sells it randomly, according to IRS, he has to calculate the costs basis on first-in-first-out (FIFO) basis. That is if the trader sells 1,300 shares, then the per share cost basis of first 1000 shares will be $20 and remaining 300 will be $10. And his account will now have 700 shares at a cost basis of $10.
If you get the stock as a gift, the cost basis will be the original cost basis that applies to the original holder.
If you get the stock as inheritance, then the cost basis will be based on the market price of the stock at original owner’s death.
If the trader reinvests the dividend in stocks, then his total cost basis is original cost + dividend reinvested + commission charges involved with all trades.