There’s a critical issue investors face at year-end. If you sold a stock, mutual fund or bond investment, what is your cost basis? You need to know the cost basis to calculate the gain or loss on your investment. The calculation can be confusing- and simply finding cost basis information can be a hassle. Use these tips to make the process easier for you.
A simple example
Fortunately, both common stocks and mutual funds trade in shares. So, let’s walk through an example of why you may need cost basis:
Assume that you sell 100 shares of IBM common stock at $70 per share. Obviously, you bought the shares that you sold.
(Side note: It’s possible to sell shares that you don’t own (short selling), but that’s a story for another day. I highly recommend the movie, “The Big Short”, which explains the concept- with a lot of humor.)
You check your trade confirmation for the IBM stock purchase data. Now, there’s actually two pieces of information that you need:
• Date of purchase: You need to know how long you held the security. That’s because the tax code may tax long-term gains at a different rate than short-term gains. The tax code changes from time-to-time on this issue. Long-term is considered to be one year or more. If you bought your IBM shares 5 years ago, your gain or loss would be long-term.
• Price paid per share: To calculate the dollar amount of gain or loss, you need the price you paid per share. Assume that you paid $60 per share for your IBM stock. Your gain would be ($70 sales price – $60 cost basis = $10 gain per share). Your total gain would be ($10 per share X 100 shares = $1,000 long-term capital gain).
If you have these two pieces of information, you can calculate your gain or loss.
Multiple purchase dates
Many investors accumulate shares of an investment over time. This can occur in several different ways:
Preview video for Live Webinar: Top 10 Personal Financial Mistakes (And the Tools To Avoid Them)
• You invest money into your mutual find each month. Those dollars are used to purchase more shares of your mutual fund.
• You decide to purchase 20 shares of IBM stock on 5 different dates over a 5-year period.
• You participate in a retirement plan at work. A 401-k retirement plan is a good example. Say that each month, you contribute 2% of your pre-tax salary into the retirement plan. Your employer matches by contributing an additional 2% into the plan on your behalf. So, the equivalent of 4% of your salary is invested each month. Those dollars are used to purchase stocks, bonds or mutual funds.
These investment approaches generate multiple investment purchases over time. The question is: how do you calculate cost basis?
Weighted average cost
For multiple investment purchases, you use weighted average cost to compute cost basis. To illustrate the concept, say that you purchased those 100 shares of IBM on 5 different dates over time:
May 2011 20 shares at $40
Dec 2011 20 shares at $50
Aug 2012 20 shares at $60
Sept 2012 20 shares at $80
June 2014 20 shares at $100
This calculation is a two-step process. First, you multiply the shares by the price for each purchase date. Second, you add up the total dollars invested and divide by the number of shares.
4-Question Survey to improve this blog (takes 2 minutes). Please help me give you more of what you need!
In this example, the weighted average cost is ($6,600 total dollars invested) / (100 shares) = $66 average cost. $66 is your cost basis.
Where do I find my cost basis?
This used to be the hard part. Both financial advisors and investors used to have a tough time accessing records to determine cost basis. The investment industry has made big improvements in keeping cost basis data- and providing that data to investors. Here are three ways to can get the information:
• Trade confirmation: As I mentioned earlier, your cost basis is listed on the trade confirmation for your purchase. Unless you’re an electrical engineer who carefully files every document you’re ever received (you know those types of people are out there….), you may not have a trade confirm from years ago.
• Investment statements, online access: Many investment statements now list cost basis for investments. You may also be able to log into your account and find that information.
• Financial advisor: If all else fails, call your financial advisor or the 800 number at your investment firm.
Where is the gain or loss taxed?
For individual investors, investment gains and losses are taxed on Schedule D for the personal tax return (Form 1040). Now, keep in mind that your retirement plan may be tax deferred or tax exempt. Check with your accountant or tax advisor for more information.
As always, this information is for educational purposes only. Consult with a tax advisor or financial advisor as needed.
Have used any of these tools? I’d love to hear from you.
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(website and blog) http://www.accountingaccidentally.com/
(you tube channel) kenboydstl
Image: Wall Street Two Signs Terrapin Flyer, Wall Street (CC BY-SA 2.0)