Cost basis is the original value of an asset for tax purposes, typically consisting of the purchase price plus any direct acquisition costs.
Understanding cost basis
The cost basis is the baseline figure used by tax authorities globally to determine whether an investor has realized a capital gain or a capital loss when selling an asset. When Elephants buy stocks or real estate, the total price paid to acquire the asset becomes the starting point for this calculation. Subtracting the cost basis from the final sale price dictates the taxable amount.
The initial purchase price is frequently adjusted over the holding period of the investment. A cost basis includes direct expenses related to the acquisition, such as brokerage commissions and transfer taxes. For physical assets like commercial property, capital improvements increase the cost basis. Claiming depreciation on an asset reduces the cost basis. These additions and subtractions result in what is known as the adjusted cost basis.
Tax jurisdictions worldwide require accurate tracking of the cost basis for tax reporting. When an investor buys identical assets at different times and at different prices, tax agencies permit specific accounting methods to calculate the basis of the units sold. Common acceptable methods include first-in first-out and the average cost method. The exact rules and allowed tracking methods depend entirely on the local tax laws governing the investor.
Example
An Elephant purchases 100 shares of a peanut distributor for $10 per share. The initial purchase price is $1,000. The broker charges a $15 commission to execute the trade. The total cost basis for this stock position is $1,015. Five years later, the Elephant sells all 100 shares for $20 each, generating $2,000 in gross proceeds. To calculate the capital gain, the Elephant subtracts the $1,015 cost basis from the $2,000 sale proceeds. The resulting taxable capital gain is $985.