What is “basis”?
Basis is a bookkeeping and market concept that tells you where profit, loss, or tax liability starts. In everyday finance it most commonly means cost basis (also called tax basis): the amount you paid for an asset after adding purchase costs such as commissions. In commodity and derivatives markets, basis usually means the difference between the cash (spot) price of a deliverable item and the price of its futures contract.
Key definitions
– Basis (general): A reference value used to determine gain or loss; meaning depends on context.
– Cost basis / Tax basis: The investor’s net purchase price in a security
…: the investor’s net purchase price in a security after adding acquisition costs (commissions, fees) and later adjusted for events such as stock splits, return of capital, reinvested dividends, depreciation, or capital improvements. Cost basis is the starting point for computing taxable gain or deductible loss when you sell or otherwise dispose of an asset.
Other key basis meanings
– Adjusted basis: Cost basis modified over time by additions (capital improvements, certain closing costs) and subtractions (accumulated depreciation, casualty losses, tax-free distributions). Adjusted basis is the relevant figure when computing gain or loss on disposition.
– Inherited (stepped-up/-down) basis: For property received from a decedent, basis is usually the fair market value (FMV) on the date of death (a “step-up” or “step-down”), not the decedent’s original cost.
– Gift (carryover) basis: Property received as a gift typically carries the donor’s basis forward, with special rules if the donor’s basis exceeds FMV at the time of the gift.
– Basis (commodity/derivatives): In futures markets, basis = cash (spot) price − futures price. It measures the difference between the local cash market and the futures contract and influences hedging results.
– Basis risk: The residual risk that price changes in the asset being hedged and in the futures contract don’t move perfectly together; it’s driven by changes in basis.
Core formulas and what they mean
– Cost basis (simple): cost basis = purchase price + purchase commissions/fees.
Example: Buy 100 shares at $20.00, pay $10 commission. Cost basis = 100 × $20.00 + $10 = $2,010; per-share basis = $20.10.
– Adjusted basis (general): adjusted basis = cost basis + capital additions − allowable deductions (depreciation, casualty loss basis reductions).
Example (real estate): Purchase house for $200,000; add $30,000 of qualifying improvements; take $10,000 depreciation. Adjusted basis = $200,000 + $30,000 − $10,000 = $220,000.
– Amount realized: amount realized = sale price − selling costs (commissions, closing costs).
– Realized gain or loss: realized gain/loss = amount realized − adjusted basis.
Example (equity sale): Sell 30 of those 100 shares at $25.00, pay $5 selling commission. Amount realized = 30 × $25 − $5 = $745. The portion of basis sold = 30 × $20.10 = $603. Realized gain = $745 − $603 = $142.
Worked example: inherited stock
– Decedent bought stock years ago for $10,000. FMV at date of death = $40,000. He bequeaths the stock to you. Your basis = $40,000 (stepped-up). If you later sell for $45,000, taxable gain = $45,000 − $40,000 = $5,000.
Worked example: gift with FMV below donor basis (special carryover rules)
– Donor’s basis = $30,000; FMV at gift = $20,000. If donee later sells for $25,000, the sale is treated in a split manner: up to FMV the donor’s basis rules may prevent a deductible loss. (These rules are nuanced; see IRS guidance.)
Futures/commodities basis example and hedging implication
– Cash price of wheat at local market = $4.00/bushel. December futures = $4.10/bushel. Basis = cash − futures = $4.00 − $4.10 = −$0.10 (negative 10¢). When a hedger sells futures to protect the cash position, profit or loss on the hedge depends on both the futures move and the change in basis. If futures and cash converge by delivery, basis approaches zero, but interim basis changes create residual gains or losses.
Practical checklist for tracking basis (keep records)
1. Save trade confirmations and brokerage statements for each purchase and sale.
2. Record commissions, fees, and reinvested dividends (DRIPs).
3. Note corporate actions: splits, spin-offs, mergers, tender offers.
4. Track improvements and depreciation for real estate.
5. Keep documentation for gifts and inheritances (date, FMV, donor basis).
6. Reconcile broker-reported basis with your own records before filing taxes.
7. For mutual funds/DRIPs, obtain year-end cost summaries from the fund or broker.
Methods for determining basis (commonly used)
– Specific identification: You state exactly which lots you sold (requires records and broker confirmation).
– First-in, first-out (FIFO): Oldest shares sold first unless you specify otherwise.
– Average cost method: Often allowed for mutual fund shares and some dividend reinvestment plans; not generally available for individual stocks unless rules permit.
– Brokers now report basis for many “covered” securities to the IRS; however, you remain responsible for accuracy on your tax return.
Tax
Tax reporting and forms
When you sell an asset, you report the sale on your tax return. Key forms and reports:
– Form 1099‑B: Issued by brokers; lists gross proceeds and often the broker‑reported cost basis. Check it against your records.
– Form 8949: Used to report individual capital asset sales and adjustments (e.g., wash‑sale disallowed losses, corrections).
– Schedule D (Form 1040): Summarizes net short‑ and long‑term capital gains or losses from all sales reported on Form 8949.
Note: brokers categorize transactions on Form 8949 depending on whether they reported basis to the IRS and whether adjustments are needed. Always reconcile 1099‑B figures with your own bookkeeping before transferring totals to your return.
Adjustments that commonly change basis
– Commissions and fees: Add purchase commissions and fees to cost basis; subtract selling commissions from proceeds when calculating gain.
Formula: Adjusted basis = Purchase price + Purchase commissions + Capital improvements (for real estate) – Accumulated depreciation.
– Reinvested dividends: Treat dividend reinvestments as purchases at the reinvestment date and price; each reinvestment creates a separate lot.
– Stock splits and consolidations: Adjust per‑share basis by dividing or multiplying so total basis remains the same.
Example: You own 100 shares with total basis $2,000 ($20 per share). A 2‑for‑1 split doubles shares to 200; new per‑share basis = $2,000 / 200 = $10.
– Corporate actions (mergers, spin‑offs): Determine whether the action is taxable; if tax‑free, allocate basis among new and old securities per IRS rules or broker guidance.
– Wash‑sale rule (disallowed losses): If you sell stock or a security at a loss and buy “substantially identical” shares within 30 days before or after the sale, the loss is disallowed and added to the basis of the repurchased shares.
Example (wash‑sale):
– Bought 100 shares at $50 (basis $5,000).
– Sold those 100 shares at $40 (proceeds $4,000) — realized loss $1,000.
– Bought 100 substantially identical shares 10 days later at $42.
– Disallowed loss $1,000 is added to the new lot’s basis: new basis = $4,200 (purchase price) + $1,000 (disallowed loss) = $5,200.
Result: The loss is deferred until those repurchased shares are sold in a non‑wash transaction.
– Gifts:
– General rule for gain: recipient (donee) takes donor’s basis (carryover basis) for computing gain.
– For loss: special dual‑basis rule applies — the donee’s basis for loss may be the lesser of donor’s
adjusted basis and the fair market value (FMV) at the date of the gift; the tax result depends on the donee’s later sale price relative to those two figures.
Rules for gifts (practical summary)
– If the donee later sells for more than the donor’s adjusted basis, the donee’s basis for computing gain is the donor’s adjusted basis (carryover basis).
– If the donee later sells for less than the FMV at the date of gift, the donee’s basis for computing loss is the FMV at the date of gift.
– If the donee sells for an amount between the donor’s adjusted basis and the FMV on the gift date, neither a gain nor a loss is recognized — the sale falls into the “no gain/no loss” zone.
Worked numeric example (gifts)
– Donor’s adjusted basis: $10,000.
– FMV at gift date: $7,000.
– Donee later sells:
– For $12,000 → Sale > donor basis: use donor basis for gain → recognized gain = 12,000 − 10,000 = $2,000.
– For $6,000 → Sale < FMV at gift date: use FMV for loss → recognized loss = 6,000 − 7,000 = −$1,000 (loss).
– For $9,000 → Sale between $7,000 and $10,000 → no gain, no loss.
Inheritance (basis at death)
– General rule: property acquired from a decedent has a basis equal to its FMV on the decedent’s date of death (this is commonly called a “step‑up” — or “step‑down” — in basis).
– Executor election: the estate can instead use an alternate valuation date (usually six months after death) for estate tax purposes when certain conditions are met; if elected, the alternate date’s FMV becomes the basis.
– Jointly owned property: for joint tenancy or tenancy by the entirety, only the deceased’s portion generally receives the step‑up. Community property states often provide a full step‑up for the entire property when one spouse dies (state law matters here).
Worked numeric example (inheritance)
– FMV of asset at decedent’s death: $250,000.
– Surviving heir’s basis if inherited at death: $250,000.
– If the heir later sells for $260,000, recognized gain = 260,000 − 250,000 = $10,000.
Adjusted basis — formula and common adjustments
– Basic formula: Adjusted basis = Original basis + capital improvements − allowable depreciation − casualty/condemnation losses (insured amounts and repairs that are not capitalized).
– Original basis for purchased property = cost (cash paid) + acquisition costs (closing costs, commissions, transfer taxes).
– For traded or noncash acquisitions, original basis generally equals the FMV of what was given up.
Amount realized (for computing gain or loss)
– Amount realized = cash received + FMV of other property
+ liabilities assumed by the buyer − selling expenses (commissions, advertising, legal fees).
Recognized gain (or loss)
– Realized gain or loss = Amount realized − Adjusted basis. This is the economic profit or loss on the transaction.
– Recognized gain or loss is the portion of the realized amount that the tax code requires you to report for tax purposes. In most ordinary sales, recognized gain = realized gain, but exceptions and special rules can defer or exclude recognition (examples below).
Worked numerical example — residential property (step-by-step)
1. Original acquisition and adjustments:
– Purchase price (cash): $200,000
– Acquisition costs (closing costs, transfer taxes): $5,000
– Original basis = 200,000 + 5,000 = $205,000
2. Post-purchase adjustments:
– Capital improvements (additions/major renovations that increase value or useful life): $30,000
– Depreciation claimed (if used as rental at any time): $20,000
– Adjusted basis = 205,000 + 30,000 − 20,000 = $215,000
3. Sale facts:
– Sale price (cash received): $260,000
– Buyer assumes a mortgage you were relieved of (liability assumed): $40,000
– Selling expenses (real estate commission, closing fees): $10,000
– Amount realized = 260,000 + 40,000 − 10,000 = $290,000
4. Realized and recognized gain:
– Realized gain = Amount realized − Adjusted basis = 290,000 − 215,000 = $75,000
– Recognized gain (typical result) = $75,000, unless an exclusion or deferral applies.
Common special rules that affect recognition or basis
– Principal residence exclusion (IRC §121): Up to $250,000 of gain ($500,000 for qualifying married couples filing jointly) may be excluded if ownership and use tests are met. This reduces recognized gain but does not change realized gain calculation.
– Depreciation recapture: When you sell property that you previously depreciated (especially rental real estate or equipment), part of the gain attributable to prior depreciation may be "recaptured" and taxed at higher ordinary-income–equivalent rates (IRC §§1245/1250). This effectively increases taxable income relative to the after-depreciation adjusted basis.
– Like-kind exchanges (IRC §1031): Properly structured exchanges of qualifying real property can defer recognition of gain by transferring basis to replacement property. (Rules are technical; consult guidance.)
– Gifts: Generally, the recipient (donee) takes the donor’s adjusted basis (carryover basis), with special rules when the donor’s basis exceeds FMV for loss purposes and potential gift tax adjustments.
– Inheritance: Basis is generally stepped up (or down) to the fair market value at the decedent’s date of death (or alternate valuation date), which often eliminates built-in appreciation for tax purposes on inherited assets.
Checklist — compute taxable gain/loss
1. Determine original basis (cost + acquisition expenses or substituted basis for noncash acquisitions).
2. Add capital improvements; subtract allowable depreciation and other decreases (casualty losses not reimbursed, etc.) to get adjusted basis.
3. Compute amount realized = cash received + FMV of other property received + liabilities relieved − selling expenses.
4. Realized gain/loss = Amount realized − Adjusted basis.
5. Apply special rules to determine recognized gain/loss (home-sale exclusion, like-kind exchange deferral, depreciation recapture).
6. Determine character of recognized gain (capital vs ordinary) — this affects tax rates and holding-period tests.
Practical notes and common pitfalls
– Keep good records of purchase documents, receipts for capital improvements, depreciation schedules, and closing statements; these determine basis and support tax positions.
– Distinguish repairs (expensed) from capital improvements (capitalized into basis). The difference affects adjusted basis and future gain.
– If property changed use (home → rental, rental → home), there are special basis allocation and depreciation-start rules. Seek authoritative guidance.
– Mortgage relief and other liability transfers commonly increase amount realized — don’t forget them.
Educational disclaimer
This is general information about basis and gain/loss computation for educational purposes only. It is not individualized tax or investment advice. For specific tax treatment, consult a qualified tax professional or the IRS guidance.
References
– Investopedia — Basis: https://www.investopedia.com/terms/b/basis.asp
Practical checklist for computing basis, amount realized, and gain/loss
– Identify original basis (purchase cost + acquisition costs such as legal fees, title, and transfer taxes).