Cost basis: What it is, how it's calculated, and where to find it
E*TRADE from Morgan Stanley
Every investor should have a solid understanding of cost basis and how it's calculated. Let's take a look at this important investing concept.
What is cost basis?
Cost basis is the total amount that you pay to buy a security. It includes the price of the security, plus adjustments for broker commissions, fees, wash sales, corporate action events, and other items that may affect your investment. You need cost basis information for tax purposes—it's used to calculate your gain or loss when the security is sold.
In some cases, determining cost basis for a specific sale can be straightforward, but it gets more complicated when you sell a group of securities that were purchased on different dates, at varying prices. In that case, there are different methods to calculate the cost basis for the sale, each with its own set of rules. The most popular methods are the first-in, first-out (FIFO) method, the last-in, first-out (LIFO) method, and the specific lot instruction (SLI) method. Other methods that may be available include the highest cost, first-out (HIFO), lowest cost, first-out (LOFO) or MinTax (MT- Minimum Tax Impact) methods.
Calculating cost basis
FIFO is the default cost basis method used by E*TRADE from Morgan Stanley, unless you select a different method of calculation. Using the FIFO method, the tax lots that you bought earliest are sold first. (A tax lot refers to shares of the same security that are purchased in a single transaction.) If you choose the LIFO method instead, the tax lots that you bought most recently are sold first. Under the SLI method, you decide which tax lots are sold on a sale-by-sale basis.
As for the other lot selection methods that may be available, the HIFO method prioritizes the sale of lots with the highest cost basis, while the LOFO method prioritizes tax lots with the lowest cost basis. Lastly, the MT-Minimum Tax Impact method sorts tax lots and prioritizes sales in a way that is intended to maximize losses and minimize gains.
The key point here is that different methods may produce different results for the same sale—for example, in certain circumstances, you might record a gain using the LIFO method but a loss using the FIFO method. Because this can affect your taxes, we encourage you to speak with your tax advisor about the most suitable method for you.
Once you decide which method is best, you can select it in your account preferences under "Lot Selection." If you decide to use the SLI method, you'll make your lot selections when you place your trades.
As we mentioned above, several factors can affect your cost basis calculation. One important factor is what is known as a wash sale. A wash sale occurs when you sell a security at a loss but establish another position in an identical (or substantially identical) security within a 61-day window (called the wash sale window). This period begins 30 days before the sale and extends to 30 days after. If a wash sale occurs, the loss is disallowed for tax purposes for that transaction. The amount of the disallowed loss is added to the cost basis of the shares you bought and is used to calculate any future gain or loss.
Please note: E*TRADE is required to track wash sale activity on an account-by-account basis. It is the responsibility of the individual investor to track wash sale details between different investment accounts, if they have more than one, and investors should seek guidance from a certified tax professional for more information about their specific circumstances.
Cost basis and your taxes
Custodians and brokers such as E*TRADE are required to report cost basis information to the Internal Revenue Service (IRS) for covered securities that you buy or sell. We are not required to report cost basis for non-covered securities.
The IRS sets rules about which securities are categorized as covered and which are considered not covered. Generally, stocks purchased after January 1, 2011 are covered, as are exchange-traded funds (ETFs) and mutual funds purchased after January 1, 2012. See the chart below for details on most commonly traded securities:
|Covered as of date
|January 1, 2011
|Mutual funds and ETFs
|January 1, 2012
|Options and other fixed income securities
|January 1, 2014
|Complex debt instruments
|January 1, 2016
|Publicly traded partnerships
|Widely-held fixed income trusts (WHFITs)
|Transferred Securities from another broker not classified as covered
Please note, master limited partnerships are not covered, and transferred securities are only covered if we receive a transfer statement from the broker.
Finding your cost basis information
You'll find cost basis information for covered securities—the same information that we send to the IRS—on your Form 1099-B. You can download your tax forms, including your Form 1099-B, by logging on to your account and going to the Tax Center.
For non-covered securities, you'll have to do additional research to determine the cost basis. If we have purchase price information, it will be included in your Form 1099-B but not reported to the IRS. Additional places to look for purchase price information include past statements, transaction records, Schedules K-1 for master limited partnership investments and the Gains & Losses page. For securities transferred to your E*TRADE account from external brokers, you can check the transfer statement, or you may need to contact the broker.
For more information on cost basis and for help making decisions about cost basis calculations, it is advisable to consult with your tax advisor.