Definition of "Cost Basis"
If you’re an owner of a property that needs to be accounted for in your return on investment or used to calculate your capital gains and losses, then the cost basis will help you along. The cost basis definition is the original cost of an asset or property. As simple as that. The term is applied to assets that are considered an investment, and the concept itself is adjusted in the business world for dividends, stock splits, and return of capital distributions.
The cost basis’s basic function is to determine the profit or capital gain of an asset and know the difference between an asset’s original cost and the current market value. During taxation, an asset’s gain in value is the means of calculation. An asset bought can appreciate or depreciate, and from the cost basis, that difference is determined, and the tax is based on the end figure.
What does Cost Basis Mean?
Any investment’s cost basis is the original cost of purchase, plus any commissions or fees involved in the transaction or the asset’s value when it becomes someone’s possession. When determining the cost basis, how the asset came to be in the owner’s possession is important. Because of that, we have the following types of cost basis:
- Assets purchased - the cost basis for purchased assets is the original cost of the asset;
- Assets gifted or intrusted - the cost basis for gifted or intrusted assets is the same as the donor’s cost basis;
- Assets inherited - the cost basis for inherited assets is also known as the stepped-up basis, as the asset is the asset’s value when the person who willed it died.
To exemplify the difference between the three and understand how to calculate cost basis, we have the following:
A purchased asset’s cost basis is the original price of the property you buy with $300,000.
A gifted asset’s cost basis is the property’s original price when the owner who gifted it to you bought it for $280,000. Here you owe capital gains tax on the $20,000.
The inherited asset’s cost basis is the property’s original price when the person who willed it to you died. So if the person who died bought it with $100,000 but its assessed value is at $300,000, the $200,000 difference does not impose capital gains tax.
Have a question or comment? We're here to help.