Cost Basis: Calculation, Adjustments, and Tax Reporting

Cost basis is the amount you’ve invested in an asset for tax purposes, and it’s the number you subtract from your sale proceeds to figure out how much of the transaction is taxable gain or deductible loss. It starts with what you paid, grows with certain costs and improvements, and shrinks with things like depreciation or returns of capital. Getting it right matters at every sale: the IRS can impose a 20% accuracy-related penalty on underpayments that come from inaccurate reporting.¹

The IRS defines basis as “the amount of your investment in property for tax purposes” and uses it to calculate depreciation, amortization, and gain or loss on sale. Sell for more than your adjusted basis and you have a capital gain. Sell for less and you have a capital loss. You’re expected to keep records of everything that changes basis along the way: purchase confirmations, closing statements, brokerage records, improvement receipts, and depreciation schedules.²

What Goes Into Your Starting Basis

Your starting basis is the purchase price plus the costs of acquiring the asset. For stocks and bonds, that means commissions, recording fees, and transfer fees. For real estate, it includes settlement and closing costs like title search fees, legal fees, recording fees, and transfer taxes; commercial buyers may also add survey costs and environmental inspections.² These are real dollars you spent to acquire the asset, and they count.

Reinvested dividends are where people quietly lose money to the IRS. Each reinvested dividend is a new purchase that adds to your total basis. Buy a stock for $1,000, reinvest $400 in dividends over two years, and your adjusted basis is $1,400.³ Forget those reinvestments and you’ll report a bigger gain than you actually had.

Inherited and Gifted Property Start Differently

The basis rules split when you didn’t buy the asset yourself.

Inherited property gets a “stepped-up” (or stepped-down) basis equal to the fair market value on the date the previous owner died.⁴ If a parent bought stock for $10,000 that was worth $200,000 at death, the heir’s basis is $200,000, and the accumulated gain effectively disappears for income tax purposes.

Gifted property is the opposite. You generally take the donor’s basis, whatever they originally paid.⁵ One trap: if the fair market value at the time of the gift is lower than the donor’s basis, you have a “dual basis.” You use the donor’s basis to figure any gain and the lower gift-date value to figure any loss. Sell for a price between the two and you have neither.

Adjustments That Change Basis Over Time

Basis rarely stays frozen. The IRS expects you to track increases and decreases so that when you sell, the adjusted basis reflects how much of your investment you haven’t already recovered.

Increases

Capital improvements raise basis. These are permanent changes that add value, extend the property’s useful life, or adapt it to a new use: adding a room, installing a new roof, putting in central air.² Routine maintenance and repairs don’t count. Painting, patching a leak, replacing a doorknob keep the property working but don’t add to basis.⁶ The one useful exception: repair-type work performed as part of a larger renovation can be treated as improvement.

Decreases

Depreciation deductions on rental or business property reduce basis every year, because the deduction is how you recover part of your investment. Insurance reimbursements for casualty losses reduce basis. So do certain energy credits.²

For securities, a return-of-capital distribution reduces basis because it’s a partial refund of your investment rather than earnings. Once return-of-capital distributions bring basis to zero, any further nondividend distribution becomes taxable capital gain.⁷ Stock splits don’t change your total basis. They spread it across more shares, so per-share basis drops.⁸

Choosing Which Shares You Sold

If you bought shares of the same stock or fund at different times and prices, you need a method to identify which shares left your account when you sold. The choice moves the reported gain or loss directly, and it can also move the tax rate by shifting whether a gain is short-term or long-term.

First-in, first-out (FIFO) is the default. Your oldest shares are treated as sold first, which tends to produce larger gains if your earliest lots were bought cheap.⁹
Specific identification lets you tell your broker exactly which lots to sell. It gives you the most control, but you need clear documentation of the instructions given at or before the sale.
Average cost is available only for mutual fund shares and shares acquired through dividend reinvestment plans. Total invested divided by total shares gives one per-share basis.¹⁰
Last-in, first-out (LIFO) treats your newest shares as sold first. Some brokers offer it, and it can shrink a taxable gain when recent buys had a higher basis.

The IRS expects consistency. You can’t bounce between methods on the same holding across years to cherry-pick outcomes.

Holding Period Sets the Tax Rate

How long you held the asset controls how the gain is taxed. Held one year or less: short-term, taxed at ordinary income rates. Held more than a year: long-term.¹¹ Long-term rates are 0%, 15%, or 20%, depending on taxable income and filing status.¹² That’s why identifying the right lot at sale time can cut your tax rate substantially, sometimes in half.

Wash Sales Adjust Basis Instead of Denying the Loss

Sell a security at a loss and buy the same or a substantially identical security within 30 days before or after, and the wash sale rule disallows the loss on your current return.¹³ The window runs both directions, so any loss sale sits inside a 61-day danger zone.

The loss isn’t lost. It gets added to the basis of the replacement shares, and the original holding period carries over.¹³ It’s a deferral, not a permanent denial. The real risk is losing track of the adjustment and either double-counting the loss or misreporting the eventual gain.

Basis on a Home Sale

Your home’s basis starts with the purchase price and closing costs, then grows with each qualifying capital improvement: adding a bathroom, replacing the entire roof, installing a security system, landscaping. Repainting or fixing a leaky faucet doesn’t count.⁶ Over years of ownership, improvement records can be worth real money at sale time.

Your “amount realized” is the sale price minus selling expenses like agent commissions, advertising, and legal fees.⁶ Gain is amount realized minus adjusted basis.

Most homeowners never pay tax on the gain. If you owned and lived in the home for at least two of the five years before sale, you can exclude up to $250,000 of gain from income, or up to $500,000 for married couples filing jointly if both spouses meet the use test and neither used the exclusion in the prior two years.¹⁴ A surviving spouse selling within two years of the other spouse’s death can still use the $500,000 figure. Basis still matters when the gain runs past those thresholds or when you don’t meet the ownership and use tests.

When Losses Exceed Gains

If your capital losses for the year top your capital gains, you can deduct the excess against ordinary income, but only up to $3,000 ($1,500 if married filing separately).¹⁵ Anything left over carries forward indefinitely.¹² An error in basis on a losing sale doesn’t just distort one return; it can misstate carryforwards for years.

What Your Broker Reports and What You Track Yourself

Brokers report cost basis to you and the IRS on Form 1099-B, but only for “covered securities.” Which securities are covered depends on when you acquired them: stocks bought for cash after 2010, mutual fund shares acquired after 2011, and certain debt instruments and options acquired after 2013 or 2015.¹⁶ For covered securities, the broker reports acquisition date, basis, gain or loss character, and any wash sale adjustments.

For noncovered securities, the basis fields may come through blank. You’re on the hook for the correct number. This is common with older holdings, inherited shares, and securities transferred between brokers without a complete transfer statement.

Starting January 1, 2026, brokers must also report basis on sales of covered digital assets, using the new Form 1099-DA.¹⁷ Before that, cryptocurrency holders carried the full burden of tracking their own basis across wallets and exchanges. Even with the new reporting, verify what the broker reports, especially for assets acquired before 2026 or moved between platforms.

Reporting the Sale

Each sale goes on Form 8949 with the asset description, acquisition and sale dates, proceeds, basis, and the resulting gain or loss. Short-term and long-term are separated. Totals flow to Schedule D of Form 1040.¹⁸

The IRS matches Form 8949 against the 1099-B and 1099-DA data brokers file. Discrepancies get flagged. Some are legitimate: wash sale adjustments, inherited shares with a stepped-up basis the broker didn’t record, or reinvested dividends the broker tracked differently. When you adjust the broker’s figure, use the adjustment columns on Form 8949 and attach an explanation. Fixing it on the front end is easier than answering an IRS notice proposing extra tax based on the broker’s number.

1
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
2
Internal Revenue Service. Publication 551 – Basis of Assets
3
FINRA. Cost Basis Basics
4
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
5
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
6
Internal Revenue Service. Publication 523, Selling Your Home
7
Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions
8
Internal Revenue Service. Stocks (Options, Splits, Traders) 7
9
Internal Revenue Service. Stocks, Options, Splits, Traders
10
Internal Revenue Service. Mutual Funds (Costs, Distributions, etc.) 1
11
Office of the Law Revision Counsel. 26 USC 1222 – Other Terms Relating to Capital Gains and Losses
12
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
13
Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
14
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
15
Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
16
Internal Revenue Service. Instructions for Form 1099-B
17
Internal Revenue Service. Instructions for Form 1099-DA (2026)
18
Internal Revenue Service. Instructions for Form 8949