Why You Should Know What You Paid For An Investment

I have a weird habit of remembering what I paid for things. Yes, I am the person that can tell you the approximate date I bought an item and how much I paid for it. This is particularly the case if I got something for a bargain. It took a while to figure out that most people really didn’t care about my Hall of Fame of great purchases, so I keep the details to myself now. (I still quietly pat myself on the back when I reflect on my bargain shopping prowess.)

The importance of cost basis

Knowing what you paid for an asset in the investing world is a little more important than bragging rights. Cost basis is the term used to describe the price and ancillary fees used to purchase an asset. It is one of those financial terms that can cause confusion but think of it simply as the price you paid for something.

Why is it important to know what was paid originally? The cost basis helps determine what, if any, tax is due when the asset is sold. When you sell an asset for more than you paid for it then you could be subject to something called a capital gains tax. This article is not a deep dive into the subject of capital gains and losses, but knowing your basis in an investment allows you to make strategic decisions to lower the tax impact of capital gains when you choose to sell.

How can I determine my cost basis?

Having documentation of the date an asset is purchased and what you paid for it is key. For instance, in the case of real estate, save your documentation on the purchase price and date of the transaction. Don’t forget to include the cost of major improvements, which may be added to the basis.

In the case of securities like stock and ETF purchases, brokerages are required to track the basis for most securities since 2011. If you purchased a stock before that time, you may have to do some work to find out the basis, but whatever you do, don’t guess it. You need to have a reason for why you believe you bought a share at a certain price in case you are questioned by the IRS. If you have proof you bought a security on a certain date, you can go to BigCharts or Yahoo Finance to find a price. If given the choice, use the adjusted price so the information you use is adjusted for stock splits.

What can I do with this information?

Let’s say you bought 100 shares of stock for $10 a share in March of 2020. You then picked up another 100 shares in March of 2021 at $15 a share. If the price is $20 and you want to sell 100 of your shares, you can sell the shares purchased in 2021 at $15 a share for a $5 per share gain rather than a $10 gain, resulting in a smaller tax bill.

Inherited assets base their basis on the fair market value at the date of death or 6 months later. This causes something called a step up in basis, which can offer significant tax savings to heirs when they sell. If someone bought a stock for $10 a share and it is now valued at $100 at their death, the heirs can sidestep the capital gains tax on $90 per share when they sell.

The basis on gifted assets is based on the original cost or the fair market value on the date of the gift. If the latter is larger than the original cost, then the original cost is used to determine gains and losses. Strategically, it may make sense to allow your assets to pass at death to receive the step up in basis. To avoid the capital gains tax, you may also want to gift those highly appreciated shares to a charity rather than an individual.

As you can see, understanding what you paid for an investment is crucial to keeping your well-earned investment gains from being taxed unnecessarily. To make sure you are exhausting your options as it relates to managing your investments, you may want to hire a tax professional. Making the right decision before you sell, even if you pay a tax preparer for help, can give you more than just bragging rights on that investment you bought at the right price.