Cost Basis Consideration

Year-end tax planning often includes determining your capital gains and losses. In order to accomplish this, you must have the purchase price of the security and the date you bought it. In other words, you will need cost basis information. Today, I am going to give you some things to consider when recording cost basis information.

Maintain Detailed Records

It is very important that you record the date and total cost of your initial purchase, dividend reinvestments and sales. When you need this information, perhaps many years later, it will be a daunting task to complete missing cost information. It is much easier to keep detailed records from the start. A spreadsheet, like the example below, is a good format to use.

Keep Track of Dividend and Capital Gains Payout Reinvestment

Taxes are paid on dividend and capital gains payouts in the year they are received. Some investors neglect to take into account reinvestment of such payouts. If dividends or capital gains payouts are reinvested, the amount invested is added to that investments total cost basis. When the stock or mutual fund is sold, the investor will then pay taxes on any capital gains realized by the sale of those shares in the year the gains are realized. For example, look at the following table:

You invested $5,000 in October 2001, and reinvested all dividend and capital gains payouts. The following January, the mutual fund paid the investor $42.24 in dividends, $75.00 in short-term capital gains, and $95.00 in long-term capital gain payout. Since you reinvested the payouts, the original cost basis in this fund increases from $5,000 to $5,212.24. You could owe more taxes if you forget to add the $212.24 in reinvestments to the cost basis. For this reason, it is important to record the reinvestments, so that part of the cost basis is not missing at tax time.

An Average Cost Basis Can Be Used with Mutual Funds, But Not with Stocks

With mutual funds, you can continually average in the cost basis with each purchase. This is done by simply adding up the cost basis and dividing by the number of shares you own, resulting in an average price per share.

The average cost is determined by dividing $1,081.49 by 97.197. Average cost per share is $11.13.

However, with stocks, you must record the cost basis each time you purchase more shares. Each purchase is referred to as a lot. Lots must be kept separate and cannot be averaged.

Record the Number of Shares Bought and the Date of the Purchase Each Time

Regardless of whether an investor uses an average cost basis for a mutual fund or records the cost of each individual lot purchased of a stock, it is still important to record the date of each purchase. Any shares sold within a year of being purchased are considered short-term. Ordinary income taxes must be paid on any short-term gains. Any shares sold after being held for more than a year are considered long-term, and capital gains taxes (currently 15%) must be paid on any long-term gains.

Commissions Are Added to the Cost Basis

Commissions, sales loads, or any other charges associated with buying or selling a security are added to the cost basis, but are not income tax deductible.

Total Cost Basis Does Not Change After a Stock Split

After a stock split, the total cost basis remains the same, but is applied to a new share amount. For example, you purchase 100 shares of a stock for $1,000. After a 2 for 1 split, you would have 200 shares of a stock with a cost basis of $1,000. The cost basis per share changed from $10 to $5. However, the total cost basis remains $1,000.

There is much to consider when dealing with cost information. Most importantly, keep good records. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.

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