When you sell an investment, your gains or losses depends on your cost basis.

If you sell for more than your cost, you end up owning capital gains taxes on the increase.  If you sell at a loss, you dont have to pay taxes on the difference; instead, you might be able to claim a tax deduction for your investment loss .

What is Cost Basis?

Your cost basis is what you paid for your investment, plus costs.

If you bought 10 shares of a stock at $30 a share, and paid a $4.99 fee, your cost basis is $304.99 ($300 + $4.99 transaction fee).

That means that you dont have to pay capital gains unless you sell for more than your cost basis.  When you sell part of your shares, you will figure your cost-basis per-share, and go from there.

Cost basis can be adjusted, as well.

Company splits and mergers can affect your cost basis, as can dividends including return of capital dividends.  You will need to make sure that you understand how your cost basis is affected by these actions.

Realize, too, that you dont have to worry about your cost basis if you are keeping your investments in your tax-advantaged account (like an IRA).  This is because you arent paying taxes on gains in the same way. Gains and losses in tax-advantaged retirement accounts dont matter, so you dont have to worry about cost basis in these situations.

Changes to Cost Basis Reporting

In the past, you were responsible for reporting what you owed in taxes, based on the information sent to you by your broker.  However, the IRS found that many people were under-reporting .

Since there wasnt any information on cost basis offered, the IRS left it up to individuals to report their gains, if they had any.  It made it pretty easy for individuals to claim that there had been no gain .

In order to recapture some of that lost revenue, there are new cost basis reporting measures being implemented this year.

Now, when you look on the 1099-B issued by brokers showing the sales proceeds from investments, you will see that your cost basis will be reported as well.  That the IRS can see the cost basis, and see what the investment sold for, and know the amount of any gain.

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The new cost basis reporting rules takes effect on stocks you purchase after January 1, 2011 (so its in effect for this tax season, encompassing tax year 2011), mutual funds purchased after January 1, 2012, and on bonds bought after January 1, 2013.

If you have questions about your cost basis, and how to report gains and losses, you can consult the IRS web site. or a knowledgeable tax professional.

What about Older Investments?

Understanding Cost Basis Reporting will help you in reporting your taxes.

Even though older cost basis reports havent appeared on tax forms in the past, you are still supposed to report your investment gains to the IRS.

However, finding cost basis can be difficult on some of your older investments especially if youve switched brokers in the interim, or if something else has happened.

If you have saved your brokerage statements, you might be able to go back to when you first bought your investment and figure out the cost basis information.  Additionally, if you have kept records using financial software, chances are that you will be able to find the information that you need.

There are services that can help you figure out how much investments cost when you bought them, even if you dont have precise records.

BasisPro and Netbasis both allow you to put information about how many shares you bought, and when you bought them, these services can help you figure out the cost basis.  You can use the information to support your cost basis reporting to the IRS.

Cost basis services are not full-proof, though.

There can be mistakes, and if you only have a general idea of when you bought, and you arent sure how many shares you started with, it will be difficult to reconstruct your cost basis.

In those cases, you might have to go with the better safe than sorry method of cost basis reporting: Assume that your basis is $0, and pay taxes on the entire gain.

Knowing your cost basis is important because it can prevent you from paying extra in taxes.

It is a way for you to subtract the costs you pay when you purchase an investment so that you are only paying taxes on your net gains.

Going forward, you are likely to have an easier time determining cost basis, since your 1099-B will include that information.  But, for investments you sell now, but bought before the reporting mandate, you will still need to be able to figure out your own cost basis.

And be able to back up your numbers in the event of a tax audit .

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