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Your Retirement . . . with Marisa Otto: ‘Cost basis’ can affect your financial investment strategy

Published in the March 29 – April 11, 2017 issue of Morgan Hill Life

Marisa Otto

Now that it’s tax season, Morgan Hill residents may want to pay close attention to every part of their financial picture because it’s important to understand the factors that affect your taxes. One area to be aware of is the “cost basis” of your investments.

Cost basis, also known as “tax basis,” is essentially your investment in a financial asset, such as a stock. Your cost basis is generally the amount you will use to determine your taxable profit or loss when you sell the investment.

Let’s look at an example. Suppose you bought 50 shares of XYZ stock for $1,000 several years ago. Now you decide to sell your shares and use the proceeds for a different investment, which you think will help further diversify your portfolio. (Keep in mind that while diversification can reduce the impact of volatility on your holdings, it can’t guarantee a profit or protect against loss.) Your shares are now worth $1,500, so you will have a $500 gain — but will you be taxed on all of it?

To answer that question, you’ll need to review what has transpired with your investment since you bought it. You know that the value has gone up $500, but let’s also assume that, during the past few years, you received $150 in dividends and you reinvested the entire amount into your shares of XYZ stock. Your adjusted cost basis would increase to $1,150, rather than the original purchase price of $1,000. Since your sale price is $1,500, your taxable gain would actually only be $350 ($1,500 minus $1,150), rather than $500. Consequently, if you were to report your cost basis as $1,000 — your original purchase price — you’ll end up paying taxes on a bigger gain than is necessary.

And we’ve just looked at one isolated example. If you were to under-report the size of your cost basis on all your investments when you sell them, you could end up paying far more in capital gains taxes than is actually necessary.

Fortunately, you probably don’t have to worry about constantly calculating cost basis on your own; if you’re investing with a financial advisor, he or she will likely provide you with statements that include these calculations.

Still, your knowledge of cost basis is important. For one thing, you can choose which particular shares of an investment to sell first. In the above example, we looked at what might happen if you bought shares at one time and then sold the same shares a few years later. But if you purchase shares of the same investment at different times, you are almost certainly buying them at different prices — and these differences in price will affect your cost basis when you sell. So your decision on which shares to sell first — as expressed in different accounting methods, such as “first in, first out” (FIFO) or “last in, first out” (LIFO) — can be more, or less, beneficial to your tax situation. Your tax professional can help you make the right choices.

By learning the basics of cost basis, you will become a more informed investor — and you can help potentially minimize your tax burden.

Marisa Otto, CFP, Financial Advisor, Edward Jones U.S.A., can be reached at (408) 778-4400, or atmarisa.otto@edwardjones.com or visit www.edwardjones.com. This column was written by Edward Jones for use by your local Edward Jones Financial Advisor. Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.