Cost Basis

Reviewed 12 August 2026 · Sourced from the Internal Revenue Code, the Treasury regulations and IRS Publication 551

What cost basis actually is

A man who worked twenty-two years at the same plant owns 400 shares of the company, bought a little at a time out of his paycheck. His transmission goes. He sells 100 shares for $9,140 and puts the money into the truck.

In February a Form 1099-B arrives. It reports the $9,140. The box marked cost or other basis is empty — the shares came out of a plan at an employer that has since been bought twice, and the brokerage cannot tell him what he paid. Whether he owes nothing on that sale or over a thousand dollars depends on a number he is expected to produce himself, from records he never kept.

That number is his cost basis.

The statute is short. 26 U.S.C. § 1012(a) says “the basis of property shall be the cost of such property.” The other half of the machine is § 1001(a), which defines gain as “the excess of the amount realized therefrom over the adjusted basis.”

Three things follow, and all three surprise people.

Basis is not what the asset is worth. The balance on your statement is market value. Basis is history, and the two only match on the day you buy.

Basis includes the friction of buying. IRS Publication 551, the reader-facing authority on all of this, adds sales tax, freight, installation, excise taxes and, for real property, “abstract fees, legal fees, recording fees, surveys, transfer taxes, owner's title insurance.” Commissions go in too. Every dollar you correctly add is a dollar you don't pay tax on later.

Basis is the taxpayer's number, not the broker's. A brokerage reports what it knows, and there are large, legal categories of things it does not know. That gap is most of this page.

Why the word adjusted carries the whole thing

Nearly every expensive mistake with basis is the same one: treating the purchase price as final. It is a starting point, and § 1016 keeps moving it, adjusting for “expenditures, receipts, losses, or other items, properly chargeable to capital account” and for “exhaustion, wear and tear, obsolescence, amortization, and depletion.”

Return of capital

Some distributions are not dividends at all — they are the company handing back part of your investment, and they appear in box 3 of a Form 1099-DIV. § 301(c)(2) says that portion “shall be applied against and reduce the adjusted basis of the stock.” Keep taking them and basis eventually hits zero; after that § 301(c)(3) treats every further dollar as gain from a sale. Real estate investment trusts and pipeline partnerships do it routinely.

Splits do nothing and everything

A two-for-one split does not change what you invested: if 100 shares cost $4,000, you now hold 200 shares with $4,000 of total basis, $20 a share instead of $40. Report a later sale using the old $40 figure and you have doubled your basis.

Wash sales, where the loss goes to hide

§ 1091(a) disallows a loss if you bought substantially identical stock within the window “beginning 30 days before the date of such sale or disposition and ending 30 days after” — sixty-one days wide, counting the sale date. The loss is not destroyed: § 1091(d) folds it into the basis of the replacement shares, so you recover it when you sell those.

Reinvested dividends, and the tax people pay twice

This is the single most expensive thing ordinary investors get wrong, and it is expensive precisely because the investor did everything right.

When a fund pays a dividend and the plan buys more shares with it, two things happen. That dividend is income to you in the year it was paid — it landed on a Form 1099-DIV and you paid tax on it, even though you never saw the cash. And the money bought shares, which are a purchase with their own basis and holding period, exactly as if you had wired the money in yourself. Skip the second part and you pay tax on the same dollars twice: once as dividend income, then again as capital gain years later.

What one year of it looks like

Take a holder of 800.0000 shares of an index fund paying $0.29 a share each quarter, reinvested automatically.

Four purchases, four lots, $934.80 of new basis in one year, 15.1514 more shares than she started with. The dividend grows each quarter without the rate changing, because she owns more shares each time — compounding, as in Stage 4 · Invest. Now stack twenty years of it into a figure nobody is tracking.

The 15% figure is the middle long-term rate. For 2026 the rate is 0% up to $49,450 of taxable income for a single filer and $98,900 for a married couple filing jointly, per Rev. Proc. 2025-32, then 15%, then 20% at the top. Which band you land in depends on taxable income, not the size of the gain.

Covered, noncovered, and the blank box on your 1099-B

26 U.S.C. § 6045(g) is why modern brokerage statements carry a basis figure at all: it requires a broker reporting a sale to also report “the customer's adjusted basis in such security” and whether the gain is long or short term. Before that rule, nobody reported basis to anyone. It did not apply to everything at once, and the phase-in dates are still the dividing line between a holding your broker can vouch for and one it can't.

Those dates come from 26 CFR § 1.6045-1(a)(15). Paragraph (a)(16) is blunt about the rest: “the term noncovered security means any specified security that is not a covered security.”

What noncovered means in practice

Box 5 on the Form 1099-B is the flag. The instructions tell the broker: “If you check box 5, you do not have to complete boxes 1b, 1e, 1f, 1g, and 2.” Box 1e is cost. A legally correct 1099-B on a thirty-year-old holding can report your proceeds and say nothing about what you paid — and if the broker fills it in as a courtesy, the same instructions relieve it of penalties for getting that figure wrong.

The holdings that are usually noncovered

Shares from an employer plan at a company that has been acquired since. A dividend reinvestment plan run by a transfer agent rather than a brokerage. Stock received when a mutual insurer went public. Anything transferred in from a broker that has closed. Anything inherited or gifted, where basis depends on facts the broker was never told.

Which shares did you actually sell

If you bought the same fund eleven times over twelve years, you own eleven lots, each with its own basis. Selling 100 shares means deciding which lot they came out of, and the decision changes the tax.

The default is first-in, first-out

26 CFR § 1.1012-1(c)(1) is the fallback: absent adequate identification, shares sold are “charged against the earliest lot the taxpayer purchased or acquired.” FIFO sells your oldest shares, which after a long holding period are your cheapest, which produces your largest gain. It is the default because it is administrable, not because it is good for you.

Specific identification, and the deadline that kills it

You can instead name the lot, and the catch is timing. Under § 1.1012-1(c)(8), identification must be made “no later than the earlier of the settlement date or the time for settlement required by Rule 15c6-1” — and under 17 CFR § 240.15c6-1 that is now one business day after the trade. A standing order with your broker counts as timely.

Average cost, for funds only

§ 1.1012-1(e) allows an average basis method — total cost divided by total shares — but only for shares in a regulated investment company (a mutual fund) or a dividend reinvestment plan held with a custodian, by written election, account by account. It is a real simplification for a DRIP with eighty tiny reinvestments in it, and it removes your ability to pick a high-basis lot there.

One honest caveat: selling the high-basis lot does not erase the gain, it leaves it in the shares you kept. A trade-off, not a free win — with one exception, covered next.

Basis when you didn't buy it: death, gifts and divorce

Property arrives in people's hands without being bought all the time. The code has a different basis rule for each route.

Inherited: the basis resets

§ 1014 replaces the basis of inherited property with its fair market value on the date of death, so the gain built up over the previous owner's lifetime is never taxed by anyone. That is the step-up in basis — automatic, no minimum estate size, and usually the largest single tax break an ordinary family ever touches. It also runs downward: an asset worth less at death than it cost takes the lower basis, and the loss is gone.

Gifted: the basis comes with it

§ 1015(a) is the opposite rule: on a gift, “the basis shall be the same as it would be in the hands of the donor.” A carryover. The asset moves and the entire built-up gain moves with it.

A second half of § 1015(a) applies when the gifted asset was already underwater. If the donor's basis “is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value.” Two bases, and a dead zone between them:

Divorce and transfers between spouses

§ 1041 says “no gain or loss shall be recognized” on a transfer to a spouse, or to a former spouse if the transfer is incident to the divorce — and (b)(2) sets the recipient's basis at “the adjusted basis of the transferor.” Plain carryover, with none of § 1015's relief for a loss.

The consequence belongs in every settlement conversation and is missing from most. $100,000 of a brokerage account with a $20,000 basis is not worth $100,000 of cash. Sold at a 15% rate the account nets about $88,000; the cash nets $100,000. More on joint assets in the divorce guide, and on survivor timing in the death of a spouse guide.

Where basis stops mattering

Inside a retirement account none of this runs. Growth in a traditional IRA or 401(k) is never a capital gain, and in a Roth IRA qualified withdrawals aren't taxed at all. Roth accounts track contributions for withdrawal ordering — sometimes called basis, but a different concept from this one.

Real property: improvements up, depreciation down

A house is where basis gets built over decades, and where the receipts get thrown away.

The rule from Publication 551 turns on permanence. A capital improvement — “putting an addition on your home, replacing an entire roof” — goes into basis. “Incidental repairs or maintenance” deductible as business expenses cannot. Patching a roof is a repair; replacing it is an improvement.

Two costs people expect to add and can't: discount points and mortgage insurance premiums. Publication 551 lists both as items that cannot be added to basis.

Then there is depreciation, which only runs on a rental or business property but runs relentlessly. § 1016(a)(2) reduces basis by the depreciation allowed or allowable, whichever is greater. Read that twice: a landlord who never claimed depreciation still takes the reduction when he sells. Skipping it forfeits the deduction and keeps the consequence.

Note where the selling costs went: commissions on a sale reduce the amount realized rather than increase basis. The arithmetic lands in the same place, but they are not part of what the property cost you. How a rental's numbers actually work sits in Stage 5 · Build Wealth and the rental property calculator.

Rebuilding a basis you don't have

Most people reading this have one holding where the number is missing and it matters: an old fund, a block of employer stock, a house. Here is the order that tends to work, and its honest limit.

1. Ask the institution for history, not tax forms. Call the brokerage, fund company or transfer agent and ask for the complete transaction history, specifically including every dividend reinvestment. Firms often hold internal records going back further than the years they report on a 1099-B, and the reinvestment history is worth the most.

2. Go back through your own returns. Every reinvested dividend was reported to you on a Form 1099-DIV, so those totals are a floor on your basis additions. The IRS will send copies of what third parties reported: a Wage and Income Transcript covers “the current and nine prior tax years” per the IRS transcript types page. Nine years is not thirty, which is why step 1 comes first.

3. If you know the dates, the prices are recoverable. A purchase date plus a historical closing price is a defensible basis, and investor-relations pages, transfer agents and library archives all carry them.

4. Chase the corporate actions. Splits, spin-offs and mergers reallocate basis, and there is a public trail. Under 26 CFR § 1.6045B-1 an issuer must report an organizational action affecting basis on Form 8937, and may satisfy that by posting it “in an area of its primary public Web site dedicated to this purpose” for ten years. Search investor relations for “8937.”

5. For a house, go to the county. The register of deeds has the recorded deed and the transfer tax paid; the title company may still have the settlement statement; the building department has permits for the major work, which date an improvement and prove it happened.

The part nobody wants to say

§ 6001 requires every taxpayer to “keep such records… as the Secretary may from time to time prescribe,” and Publication 551 puts it in one line: “You must keep accurate records of all items that affect the basis of property.” If you cannot substantiate basis, the practical default is zero, and a zero basis means the entire sale price is gain. On the $60,000 sale earlier, that is a $9,000 federal tax bill on a $15,000 investment — the argument for doing step 1 before you sell, not after.

What trips people up

• Trusting box 1e. On a noncovered security the broker need not fill it in and is not penalized for filling it in wrong. Check box 5 first.
• Leaving out reinvested dividends. The most expensive error here, and the one made by the most careful investors, because reinvesting is the responsible choice and the recordkeeping is invisible.
• Trying to pick lots at tax time. The deadline is settlement, one business day after the trade. Miss it and FIFO already decided — the cheapest shares, the biggest gain.
• Not knowing which method your account is on. Average cost on a fund account is an election that sticks.
• Signing a house or a stock position over to a child while still alive. It avoids probate and hands over the old basis along with the asset. The step-up in basis page runs that comparison in dollars.
• Assuming skipped depreciation preserves basis. § 1016(a)(2) uses the allowable amount if it exceeds what was allowed. You lose the deduction and keep the reduction.
• Splitting a divorce settlement without looking at basis. A low-basis account and cash of the same face value are not the same asset.
• Rebuying in a second account after a loss sale. The wash sale rule applies across your accounts. Only the tracking is per account.
• Throwing away closing statements and improvement receipts. A folder with a roof invoice in it is worth more per page than anything else in the house.

The figures on this page are checked against the source that publishes them, and dated. Published rates move after the release named above — the linked source always carries the current number. This page explains a term; it does not recommend a product.