Why cost basis matters
Cost basis determines your capital gains or losses when selling investments. Inaccurate tracking can lead to overpaying taxes or IRS problems.
Common Cost Basis Errors
- • Using purchase price instead of adjusted basis after stock splits
- • Not tracking dividend reinvestments as new tax lots
- • Missing step-up in basis from inherited assets
- • Forgetting return of capital adjustments from mutual funds
- • Losing records from brokerage account transfers
Basic tracking system
Record every purchase
Date, quantity, price per share, total cost including commissions
Track each tax lot separately
Different purchase dates = different tax lots with their own cost basis
Choose accounting method
FIFO, LIFO, specific identification, or average cost (mutual funds)
Adjust for corporate actions
Stock splits, mergers, spin-offs, and return of capital distributions
Handling complex situations
Stock Splits & Dividends
Stock splits: Divide original cost basis by split ratio
Stock dividends: Allocate cost between old and new shares
Spin-offs: Allocate original basis based on fair market values
DRIP & Mutual Funds
DRIP: Each reinvested dividend creates new tax lot
Average cost: Allowed for mutual fund shares
Return of capital: Reduces cost basis, not taxable income
Cryptocurrency Complexity
Every transaction is taxable
Buying coffee with Bitcoin = sale at fair market value vs cost basis
DeFi complications
Staking rewards, liquidity pool tokens, airdrops - all need basis tracking
Exchange transfers
Moving crypto between wallets/exchanges isn't taxable but basis stays with coins
Tools and software
| Tool Type | Best For | Cost | Limitations |
|---|---|---|---|
| Broker provided | Single account tracking | Free | Lost on transfer |
| Excel/Sheets | Simple portfolios | Free | Manual updates |
| TurboTax/TaxAct | Tax season imports | $50-200 | Tax season only |
| Portfolio trackers | Multiple accounts | $100-300/yr | Learning curve |
| Crypto tools | DeFi tracking | $200-500/yr | Still evolving |
Record retention
What to Keep
- • Brokerage statements: Monthly/quarterly
- • Trade confirmations: Every buy/sell
- • Dividend statements: All distributions
- • Corporate action notices: Splits, mergers
- • Form 1099-B: Annual broker reports
- • ACATS transfer records: Account transfers
- • Gift/inheritance docs: Stepped-up basis
- • Crypto transaction logs: All DeFi activity
Retention period: 7 years after sale, or indefinitely for assets still held
Tax optimization strategies
Tax-Loss Harvesting
Sell losing positions to offset gains, but watch wash sale rules
Specific lot identification lets you choose high-basis shares to sell
$3,000 annual limit on net losses against ordinary income
Long-term vs Short-term
Hold investments over 1 year for preferential capital gains rates
Track purchase dates carefully—even a day can matter
Consider timing of sales to optimize tax brackets
⚠️ Red Flags for IRS
- • Inconsistent cost basis: Different amounts reported to IRS vs your return
- • Missing 1099-B forms: Failing to report all brokerage transactions
- • Impossible basis: Cost higher than historical stock prices
- • Zero basis crypto: Not tracking acquisition costs properly
- • Round numbers: Obviously estimated rather than actual costs
💡 Pro Tip
Set up automatic downloads from your broker to export trade data monthly. Most brokers provide CSV exports that can be imported into spreadsheets or tax software. Don't wait until tax season to organize this data.
Frequently Asked Questions
What happens if I lose my cost basis records?
You can reconstruct basis using old brokerage statements, tax returns, and historical price data. For inherited assets, get a date-of-death valuation. Some online services help reconstruct missing data for a fee.
How do I handle employer stock options?
For ISOs, basis is the exercise price. For NQSOs, basis includes the exercise price plus the amount reported as ordinary income. RSUs have basis equal to fair market value when they vest.
Do I need to track cost basis in tax-advantaged accounts?
Not for tax purposes since gains/losses aren't taxable inside 401(k)s, IRAs, etc. But tracking helps with rebalancing decisions and understanding your portfolio performance.
What if the IRS cost basis doesn't match mine?
File Form 8949 to report the correct cost basis with explanation code. Common reasons include inherited assets, wash sales, or missing corporate action adjustments from your broker.