Cost basis explained

Your basis in property is generally its cost. Exceptions can apply under other provisions of the same tax subchapter and under subchapter C concerning corporate distributions and adjustments, subchapter K concerning partners and partnerships, and subchapter P concerning capital gains and losses. For property acquired at any time, your adjusted basis for determining gain or loss starts with the basis determined under section 1012 or another applicable provision. You then apply the adjustments required under section 1016.

If you pay cash for a security, your initial basis includes the total cash you paid or the amount credited against your account for that security. You also include the commissions and transfer taxes paid to buy it. If you adequately identify the particular stock shares or bonds you sell, you use those securities' cost or other basis. If you bought and sold securities at different times and in different quantities and cannot adequately identify the shares sold, you generally use the basis of the securities you acquired first, except when you use an available average basis method.

Your basis in property received as a gift is generally the donor's basis. Your basis in inherited property is generally its fair market value at the date of death. An exception applies to certain appreciated property that you or your spouse gave to the decedent during the one year period ending at death. If you inherit that property, you use the decedent's adjusted basis immediately before death rather than its fair market value.

Before you figure gain or loss on a sale, exchange, or other disposition, you must usually adjust your property's basis. Capital improvements increase it. Depreciation, amortization, and depletion decrease it. You use basis to calculate those deductions, casualty losses, and gain or loss on a disposition. You must keep accurate records of all items affecting your basis so you can make these computations.

Your home's adjusted basis generally includes your acquisition cost plus capital improvements, less casualty loss amounts and other decreases. If you financed the purchase with a mortgage, the purchase price already includes the mortgage proceeds. Those proceeds are therefore already included in your adjusted cost basis. General repairs do not increase your basis. At least some work that adds to your home's value and prolongs its useful life qualifies as a basis addition, and improvements needed after substantial hurricane damage would likely qualify.

If a gift's fair market value is below the donor's adjusted basis when you receive it, your basis depends on whether you have a gain or loss when you dispose of it. To figure gain, you use the donor's adjusted basis, increased or decreased by any required adjustments during your ownership. Keep records of both the donor's basis and the property's fair market value when gifted. You may need either amount depending on your eventual sale price.

You can have neither gain nor loss when selling gifted property under the dual basis rules. This happens if using the donor's adjusted basis to calculate gain produces a loss, while using fair market value to calculate loss produces a gain. When both conditions apply, you recognize neither gain nor loss on that sale or disposition.

When an estate must file a federal estate tax return on Form 706, you generally receive Schedule A of Form 8971 from the executor as a beneficiary. That schedule reports the estate tax value of property distributed to you. Certain beneficiaries must use the reported value as their initial basis in the inherited property.

If you used property personally before converting it to rental use, your depreciation basis is the lesser of two amounts. Compare your adjusted basis with the property's fair market value when you change its use. You use the lower amount for depreciation.

If you buy buildings for a price that also includes their land, you must divide your cost between the land and buildings to determine the buildings' depreciation basis. You allocate cost to each asset according to its fair market value relative to the fair market value of the entire property when purchased. Each asset's share of the total purchase cost follows that ratio.

A return of principal is often called a return of capital or a nondividend distribution. It returns part of your original investment and reduces your basis. You are not taxed on that return of capital until after your basis reaches zero. If you cannot identify specific shares, you reduce the basis of your earliest stock purchases first. You may find this distribution information in box 3 of Form 1099 DIV.

Once your basis reaches zero, you report additional returns or distributions other than dividend distributions on Schedule D of Form 1040 and Form 8949. You report gains from stock held longer than one year as long term capital gains.

You can generally use average basis for stock in most mutual funds or other regulated investment companies, or stock acquired after 2010 through a qualifying dividend reinvestment plan, if you leave the shares with a custodian or agent in an account and acquire identical shares at different prices in that account, and your calculation includes all unsold shares of identical stock in the account. A sale can nevertheless produce both short term and long term gains or losses. To determine your holding period, you treat the shares disposed of as the shares acquired first.

To calculate your S corporation stock basis, you start with your initial capital contribution or the initial cost of stock you purchased, as you would for a C corporation. You then adjust that amount for items passed through from the S corporation. Income increases your stock basis. Losses, deductions, and distributions decrease it.

Your Schedule K 1 reflects the S corporation's income, loss, and deduction items allocated to you for the year. It also shows the nondividend distribution you received. However, it does not state the taxable amount of that distribution. You determine the taxable amount using your stock basis.

If you receive a nondividend distribution from an S corporation, it is tax free to the extent it does not exceed your stock basis. You do not consider debt basis when determining the distribution's taxability. The portion exceeding your stock basis is taxed as a capital gain on your personal return. You have a long term capital gain if you held the S corporation stock for longer than one year.

If your S corporation repays debt to you whose basis has been reduced, you have gain. Part II of Form 7203 was designed to report and segregate open account debt and highlight gain resulting from repayment of debt with reduced basis.

Under section 704(d), your distributive share of partnership loss, including capital loss, is generally allowed only up to your adjusted basis in your partnership interest. This is called your outside basis. You measure that limit at the end of the partnership year in which the loss occurred.

If you contribute property to a partnership, the partnership generally uses your adjusted basis at contribution to determine depreciation, depletion, gain, or loss. It increases that basis by any gain you recognize when you contribute the property.

Unless your partnership interest is completely liquidated, property other than money distributed to you generally carries the partnership's adjusted basis immediately before distribution. A limit applies to your basis in that property. It cannot exceed your adjusted basis in your partnership interest, reduced by any money you receive in the same transaction.

Your RSU basis is the full value taxed as wages when your shares vest, so only growth after vesting is taxed as capital gain when you sell later, but brokers routinely report zero basis because their reporting rules allow only the cash you paid, which is nothing for RSUs.