"Cost basis" is likely a term you’ve heard before. But do you really know what it means, why it’s important and why you hear about it more around tax time?
If this term has ever left you scratching your head in confusion, we’ll break it down for you.
What is cost basis?
As you can see from the chart, it’s the amount you paid for an investment, including commissions, fees and reinvestments.
This chart uses a math equation to explain how to figure cost basis for any investment. Cost basis equals the total purchase price (including commissions, fees and reinvestments) minus principal return, nontaxable distributions or cost basis of prior sales and plus or minus any adjustments that are made because of corporate actions such as spinoffs or mergers.
How is cost basis used?
When you sell or redeem an investment, cost basis is used to calculate a capital gain or loss. Your tax professional uses this information to determine whether you owe capital gains tax.
If I have a capital gain, how am I taxed?
It depends on how long you held the investment.
- One year or less: Capital gains are considered short term and subject to tax at ordinary income rates.
- More than one year: Capital gains are considered long term and subject to tax at capital gain rates, which are lower than ordinary income rates.
What if I have a capital loss?
If capital losses, short or long term, exceed capital gains for the tax year, the losses generally offset up to $3,000 of ordinary income ($1,500 if married filing separately). Any additional losses may carry forward to the next tax year. Ask your tax professional for more details.
What is a "covered" vs. "non-covered" security?
Cost basis regulations require Edward Jones and other brokerage firms to report cost basis to the IRS when securities "covered" by the regulations are sold. Securities acquired before certain effective dates, and some specific securities, are referred to as "non-covered" securities. Form 1099-B reports cost basis (and other information) for sales of covered securities to clients and the IRS. For non-covered securities, cost basis is provided to clients on Form 1099-B but is not reported to the IRS.
Covered securities are those purchased on or after certain effective dates:
|Effective date||Covered securities|
Jan. 1, 2011
|Stock shares not in a dividend reinvestment plan|
Jan. 1, 2012
Mutual fund shares
Stock shares in a dividend reinvestment plan
Jan. 1, 2014
Fixed-income securities designated by the IRS as "less complex"
Generally includes bonds, notes and certificates of deposit (CDs) with a determinable yield
Jan. 1, 2016
Fixed-income securities designated by the IRS as "more complex"
Generally includes convertible debt instruments, stripped bonds or coupons (STRIPs) and inflation-indexed debt instruments (TIPs).
Securities are non-covered if they are:
- Purchased before the applicable effective dates above; or
- A security type specified by the regulations as being non-covered regardless of when purchased: Collateralized mortgage obligations (CMOs), real estate mortgage investment conduits (REMICs), mortgage-backed securities and short-term debt instruments with maturities of not more than one year.
Transfer of cost basis between firms
When covered securities are transferred between brokerage firms, regulations generally require the transferring firm to provide cost basis to the receiving firm. If cost basis is provided when you transfer covered shares to Edward Jones, it will be tracked by our system.
Cost basis for equities and fixed-income securities
- You direct us, at the time of the sale, to sell specific shares; or
- Shares are missing cost basis at the time of the sale and you do not direct us to sell specific shares. In this case, the shares without cost basis are sold first.
How do I specify which shares are sold?
You can choose which shares of stock you would like to sell if you specify them before the trade’s settlement date. Regulations generally prohibit changing the selection after the trade settles. Many considerations may affect which shares you should sell, so you should work with your tax professional and financial advisor prior to executing a sale of specific shares.
Cost basis for open-end mutual funds
For domestic open-end mutual funds, Edward Jones uses the average cost method to calculate cost basis. Regulations generally require brokerage firms to calculate separate averages for covered and non-covered shares.
When covered shares are sold, the average cost per share of the covered shares will be used to determine cost basis and resulting capital gain or loss, and when non-covered shares are sold, the average of the non-covered shares will be used.
For tax questions, consult your tax professional. For investment-related questions, please contact your local Edward Jones financial advisor.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation. This content should not be depended upon for other than broadly informational purposes. Specific questions should be referred to a qualified tax professional.