Basis in property is generally understood to be your initial investment in that property. Whether it is stock or real estate it is important to always track your basis.
When you receive information from your broker each year, the information should include what you paid for that investment. However, it is common to see the basis not reported to the IRS. If you are unable to prove what your basis in stock is, the IRS considers the basis to be zero. This makes the whole amount of the sale of the stock as a capital gain. If the basis of the stock (or purchase price) is known and can be documented it can lower the amount of the capital gain.
For example, if you purchased XYZ stock for $25 a share and then later sell those shares at $28 each, the amount of capital gains reported is the difference or $3 per share. However, if you are unable to prove that you purchased the shares for $25 each, you must claim the entire $28 as capital gains. It is the same if you sell the shares at a loss causing a capital loss to be reported on your tax return. If the broker has not reported the basis to the IRS, it becomes the taxpayer's responsibility to prove the basis. If the basis amount is not reported to the IRS, the IRS automatically assumes the total sale of the investment is all capital gains.
Some taxpayers do not retain their initial investment information. When they switch brokerage firms, basis information can be lost or unaccountable. It is important to always know your basis in your investment.
What if you inherit the stock?
The basis is the value of the stock on the date of the original owner's death. If you receive stock as a gift, the basis is the amount that was originally paid for the investment by the giver, unless the market value of the investment on the date the gift was given was lower.
The basis of real estate property often changes from the cost of the investment. If there are improvements made that add to the value of the property, the basis is increased. It is important to track improvement costs so that an accurate basis in the property can be determined when the property is sold. Settlement costs when purchasing or selling the property increase the basis of real property. Settlement or closing costs such as: abstract fees (title fees), charges for installing utility services, legal fees, recording fees, surveys, title insurance and any amount the seller owes such as back taxes, interest or mortgage fees can add to the value of the home's basis. These costs make it important to keep both the purchasing settlement statement (HUD) and the closing settlement statement to accurately determine the actual gain or loss the sale causes.
Not knowing the basis of your investment, or not being able to prove the basis, can increase the amount of capital gains reported on the tax return.
Tracy Bunner is an enrolled agent and tax preparer with an office in Harrisville. She can be reached at 801-686-1995 or at firstname.lastname@example.org.