Calculating Cost Basis

Calculating the cost basis of a single purchase is not very complicated. Although it is important to verify which costs associated with your purchase are included in the cost basis according to the IRS guidelines. Because the IRS guidelines are subject to change, you should check each time you are setting up a new asset account. However, when your purchase is ongoing, such as a stock reinvestment program, the numbers can get a little complicated. Of course, the only reason it is important to calculate your cost basis accurately is to avoid paying excessive income taxes, or worse yet, income tax penalties.

Things You'll Need

• Original cost Cost associated with purchase Current IRS Guidelines for Cost Basis Spreadsheet software (preferable)

Instructions

1. Keep records of everything that can affect the basis of the property. It can be difficult to recreate these records years later when your memory of events has dimmed. Therefore, write everything down in a notebook, or start a spreadsheet at the time of purchase. The cost basis is used to calculate depreciation, casualty losses, amortization, depletion, and the loss or gain on the final sale or disposal of property.

2. Calculate the original cost basis at the time of purchase. This includes what you paid for the asset. It does not matter if you paid by cash, exchange, incurring debt or providing services. On top of the actual purchase price, you may add the following items to your cost basis that were incurred in the purchase. Some items are sales tax, freight, installation, testing, excise tax, revenue stamps, recording fees, legal fees, accounting fees, real estate taxes, commissions and transfer fees.

3. Increase your cost basis whenever you complete major improvements to an asset such as a major remodeling project, assessment cost for local improvements, or you purchase similar property such as more shares of a certain stock.

4. Decrease your cost basis whenever a portion of the asset is sold, destroyed, or by the accumulated depreciation.

5. Choose a method to use when disposing of all or part of an asset for your cost basis. You may use FIFO, which stands for "first in first out," or you may use the averaging method. For example, say you purchased 10 shares of a certain stock on a monthly basis for 5 years, and now you have decided to sell 50 shares. You could look back and find the cost that you paid for the first 5 months, add those cost together, and use that as the cost basis for the sale. That would be using FIFO. Don't forget to add any commission fees that you paid. You could add up the total cost and all commissions for the 5-year period, and divide the total by all of your shares. That would give you an individual average price that you could multiply by 50 to get the average cost basis for your sale.

Tips & Warnings

• Both average and FIFO are acceptable methods of calculating cost basis for sale of assets, so you may want to calculate both and use the one that gives you the best tax advantage.

• Tax laws tend to change, so be sure to go to the IRS website (see Resources below) for the latest information to avoid penalties.

Resources

• IRS Publication 551 Basis of Assets