If you purchase assets for investment purposes, you’ll need to track your cost basis. The Internal Revenue Service (IRS) uses this information to determine tax liabilities. After selling a given asset, you’ll have to report your cost basis for that asset on your taxes. By properly tracking, as well as reporting your cost basis, you can rest assured knowing that you are filing your taxes correctly.
What Is Cost Basis?
The term “cost basis” refers to the original purchase price of an asset. It’s used to calculate capital gains and capital losses (see below).
Assets are items of monetary value. They can include tangible items like real estate and equipment, and they can include intangible items like stocks and bonds. The value of an asset, however, may change over time. Assets typically don’t retain their original value indefinitely. Some of them will appreciate, whereas others will depreciate. Regardless, the cost basis of an asset is the original purchase price. It represents the price you paid to acquire the asset.
Cost Basis and Capital Grains vs Losses
The IRS requires taxpayers to report their cost basis after selling assets. When you sell an asset, you’ll either incur a capital gain or a capital loss. Capital gains occur when you sell an asset for a higher price than that for which you purchased it. Capital losses, on the other and, occur when you sell an asset for a lower price than that for which you purchased it. The IRS calculates capital gains and capital losses using the reported cost basis of assets. The difference between the sale price of an asset and the cost basis of the asset will determine capital gains or capital losses.
With capital gains, you’ll incur tax liabilities. There are short-term and long-term capital gains. Short-term capital gains involve assets that are held for less than one year. Long-term capital gains involve assets that are held for longer than one year. Tax rates vary depending on income, but short-term capital gains always come with higher tax liabilities than long-term capital gains.
Selling an asset is considered a taxable event. And like other taxable events, you’ll have to report it to the IRS. When filing your taxes for the year in which you sold the asset, you’ll need to report your cost basis. It’s essentially the original purchase price of the asset, and it will determine your capital gains or capital losses.
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