How to Calculate a Cost Basis for Capital Gains

by Dale Bye

In general, the price you pay for stock in a company or shares in a mutual fund -- plus any sales charges or transaction fees -- constitutes your cost basis in figuring your tax liability from the sale of those shares. However, if you make subsequent purchases of the same stock or mutual fund, or if you reinvest dividends or other income, the Internal Revenue Service (IRS) gives you some options for determining your cost at tax time. Knowing the methods available can save you money when you file your taxes.

FIFO -- First In, First Out -- Method

Create a spreadsheet with four columns: 1. Date of purchase; 2. Number of shares; 3. Total price paid for the shares, including transaction fees or sales charges; and 4. Price per share. If you do not buy any additional shares before you sell the stock, your cost basis for each share you sell will be the price per share.

Add additional lines on your spreadsheet for each subsequent purchase, including income reinvestment.

For each block of shares sold, start at the earliest date of purchase, using the price per share column to determine your cost basis. Let's say you bought 100 shares on June 1, 2010, for $10 each and 200 shares on September 1, 2010, for $12 per share. If you sold 200 shares on October 15, 2011, your cost basis would be 100 shares at $10 per share -- first in -- and 100 shares at $12 per share.

If you own a stock that splits, add two columns: "Shares after split" and "Split cost per share." Divide the new number of shares into the original cost for each purchase date to get the split cost per share. For example, your original purchase was 100 shares for $1,000 -- $10 per share. If the stock split so that you now owned two shares for every one purchased, your cost basis would now drop to $5 per share.

Specific Identification Method

Follow the first two steps used in the FIFO method.

For each block of shares sold, you can pick stocks from a specific purchase date to include in the sale. Let's say you bought 100 shares on June 1, 2010, for $10 per share and 200 shares on September 1, 2010, for $12 each. If you sell 200 shares on October 15, 2011, you can include 50 shares from the first purchase date and 150 shares from the second purchase date.

For clarity, make a new entry line for the remaining shares from every block used in the sale. So now, your spreadsheet would show lines for 50 shares bought on June 1, 2010, at $10 per share and for 50 shares bought on September 1, 2010, at $12 per share.

If you own a stock that splits, add two columns: "Shares after split" and "Split cost per share." Divide the new number of shares into the original cost for each purchase date to get the split cost per share just as you did in Section 1, Step 4.

Mutual Funds Average Cost Method -- Single Category

Because mutual funds typically are bought and sold in dollar amounts, not in share blocks, and fund income often is reinvested, mutual fund accounts generally hold fractional shares. The IRS allows you to set your cost basis based on the average cost of shares held at the time of the sale. You'll still start with a spreadsheet, but this time, you'll only need three columns: 1. Date of purchase; 2. Number of shares; and 3. Total price paid including sales charges.

Add additional lines on your spreadsheet for each subsequent purchase, including income reinvestment.

At the time of a sale, figure the total number of shares purchased and the amount paid.

Divide the total amount paid by the total number of shares purchased to get a per-share cost basis. For example, you originally bought $10,000 worth of Pretty Good mutual fund at $19.43 a share, putting 514.668 shares in your account. In September, you reinvested $58.63 of dividends and received 3.070 shares. Then in December, you reinvested $532.14 of long-term capital gains -- 28.007 shares -- and $61.20 in dividends -- 3.221. Your total amount paid now is $10,651.97 for 548.966 shares. Your average cost basis is $19.4037 per share. .

Multiply the per-share cost basis by the number of shares sold for a total cost basis. For example, when you redeem $5,000 of Pretty Good in early January for $18.98 a share, you would surrender 263.435 shares. Your cost basis for those shares would be $5,111.67, which is 263.435 x $19.4037 -- and a capital loss of $111.67.

Make a separate entry line. Enter the date sold, the remaining number of shares and the remaining total cost.

Follow Steps 2 through 6 for each additional sale.

Mutual Funds Average Cost Method -- Double Category

Create a spreadsheet with three columns: 1. Date of purchase; 2. Number of shares; and 3. Total price paid including sales charges.

Add additional lines on your spreadsheet for each subsequent purchase, including income reinvestment.

At the time of sale, separate the entries into two categories: shares bought more than a year before the sale and those purchased within a year. You can treat each category differently at tax time.

Figure the total number of shares and the total amount paid for each category.

Divide the total amount paid by the total number of shares to get a per-share cost basis for each category. For example, you bought $10,000 of The Best Ever mutual fund and redeemed all of it 13 months later. Your original purchase resulted in 512.295 shares, and beginning a couple of months after your original purchase, you added at various times 23.171 shares through $476.76 in dividends and capital gains reinvestment. At the time you cashed in your shares, you would have an average price of $19.52 for shares held more than a year and $20.36 for shares held less than a year.

If you redeem only a portion of your shares, use the cost-basis from the block, which gives you the more advantageous tax rate. The shares purchased more than a year before the sale are considered "long-term" capital gain/loss. The remainder are considered "short term." Long-term capital gains are taxed at 15 percent, and short-term capital gains are taxed at the highest rate you pay for ordinary income.

If you sell a portion from the long-term block, make a separate long-term entry line for the remaining number of shares and the remaining total cost in that category.

Follow Steps 2 through 7 for each additional sale.

Tips

  • The IRS considers FIFO the default method for stock sales, and it's also the method most brokerages use unless you specify otherwise.
  • Your brokerage or mutual fund administrator will give its default method for determining cost basis. If you specify a different method at the time of a sale, you should receive written confirmation of your choice after the sale.

Warnings

  • If you sell any mutual fund shares using the Average Cost method, you can never use another method for figuring your cost basis in that particular fund. But you may use a different method for figuring the cost basis for shares in other funds, even those within the same fund company.
  • You can switch between the FIFO and Specific Identification methods for the same stock or fund if you keep specific records of your sales and alert your brokerage of your intentions with each sale. Reminder: If you switch to the Average Cost method, you cannot return to another cost basis method.

Items you will need

  • Statement(s) listing all your share purchases of a particular stock or mutual fund, including income reinvestments
  • Computer or calculator
  • Spreadsheet or spreadsheet software

About the Author

Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.

Photo Credits

  • Stockbyte/Stockbyte/Getty Images