When you sell investments in your taxable accounts, you need to report either a capital gain or loss on your income tax return. Generally, this is the price the investment sold for, minus your cost basis, which often includes the price you paid plus purchases made by reinvestment of dividends or capital gains distributions, and commissions and fees you paid for the transaction.
Calculating your gains or losses can be pretty easy if you purchased a stock for $20 and sold it at $60 and never reinvested their dividends; however, many investors have reinvested dividends or bought shares of the same stock over the span of many years. This can make determining your cost basis rather difficult. Brokerage firms only started tracking and reporting the cost basis of investments beginning in 2010 through 2013; therefore, if you have a long-term holding dating back to 2009 or prior, or you transferred your holdings to a new custodian, your broker may not be able to provide accurate cost basis information.
This is why it is so important to keep your transaction records for your investments. While it still may be difficult to sort through 10 plus years of paperwork, you may be able to determine your actual cost basis—especially if you also have records of stock dividends or non-dividend distributions you received.
If you cannot determine the cost basis of your investment because of a lack of records, your broker will generally use a “first in, first out” (FIFO) method to determine your cost basis. First in, first out requires you to use the purchase price of your oldest shares, which is often the least expensive purchase price, as stocks tend to increase in value, and often results in a larger tax bill. Let’s say you first purchased a stock at $20 a share, and then dollar-cost-averaged your purchases over the next 10 years, resulting in an average cost throughout the 10 years around $60 per share. You then sold some stock shares for $200 per share. If you use the FIFO method, your cost basis per share is $20. Your capital gain is $180 times the number of shares you sold. As you can see, that can add up quite quickly.
If you keep accurate accounting and cost basis information, you can track your securities by tax lot. You could choose to sell your highest cost positions first, and possibly have a lower tax bill. For example, you could have specified to your broker to sell the shares purchased April 23, 2015, for $145 per share. While it is generally best to sell long-term positions first, depending on the tax lot, sometimes you may be able to sell a newer position for a lower capital gain. This example would result in a capital gain of $55 per share. This is also known as the “specific share identification” method for determining cost basis.
If you have investments that you know you will have to use the FIFO method for determining cost basis and you want to avoid or reduce your capital gains, you could consider donating those shares to charity. When you donate appreciated stocks, your gift is worth the fair market value of the stocks when transferred. You can avoid paying the capital gains, and the charity receives more than if you had sold the shares, paid the capital gains tax, and then donated the cash.
You can also set aside highly appreciated investments to pass to your heirs at your death. Your heirs will receive a step-up in basis for inherited property, meaning they could sell the stock shortly after your death and their cost basis would be the value of the stock at the time of the inheritance.
The bottom line is that it is extremely important to track the cost basis information for your investments. If you have questions regarding your cost basis, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
