Cost
Basis Consideration
Revised By: Charlie B. Holloway, CFP®
The Henssler Financial Group Position Paper
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.
Date | Symbol | Bought
or Sold | #
of Shares | Price
Per Share | Total
Cost |
05-17-98 | XYZ | Bought | 100 | $10 | $1,000 |
12-13-01 | XYZ | Bought | 100 | $15 | $1,500 |
12-02-02 | XYZ | Sold | 75 | $12 | N/A |
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:
Date | Transaction | #of
Shares Purchased | Price
Per Share | Total
Amount Invested |
10-15-01 | Initial
Purchase | 416.667 | $12 | $5,000 |
01-05-02 | Dividends | 3.017 | $14 | $42.24 |
01-05-02 | Short-Term
Capital Gain Payout | 5.357 | $14 | $75.00 |
01-05-02 | Long-Term
Capital Gain Payout | 6.786 | $14 | $95.00 |
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.
Date | Symbol | #
of Shares Purchased | Price
Per Share | Total
Dividend Reinvestment |
08-02-01 | ABCDE | 90.909 | $11 | $1,000 |
10-05-01 | ABCDE | 3.271 | $12 | $39.25 |
01-06-02 | ABCDE | 3.017 | $14 | $42.24 |
Total
Shares | 97.197 | Total
Cost | $1,081.49 |
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.