What is Cost Basis?
Essentially, cost basis describes your client’s total investment in a particular asset. Cost basis begins with the original cost or value of an asset and adjusts it for factors such as stock splits, dividends and returns of capital distributions. It’s an indicator of whether an investment results in gains or losses, which is what your client will need to report for tax purposes.
Determining Cost Basis
The cost basis of your client’s asset(s) depends largely on how they acquired it in the first place.
Stock purchases: The cost basis for stocks includes the cost per share plus any commission your client paid. Say, for example, they bought 10 shares of ABC Company stock at $20 per share.
$20 X 10 shares = $200 (investment)
$200 (investment) + $100 (commission paid to a broker) = $300 (cost basis)
$300 (cost basis) / 10 shares = $30 (cost basis per share)
Now, let’s say your client sells those 10 shares for $50 each and pays $100 in commission on the sale.
$50 X 10 shares = $500 (sales price of shares)
$500 (sales price of shares) – $100 (commission paid to a broker) = $400 (cost basis)
$400 (cost basis for sale) – $300 (cost basis for investment) = $100 (net from transaction)
In this example, the sale of the stock ultimately resulted in $100 in gains.
Gifts: The basis for stock that is gifted to a client can’t be determined until that stock is sold. If it’s sold for a profit, the basis from the previous owner carries through to your client. If it sells for a loss, the basis is the value of the asset when it was gifted, or it is the same as the previous owner’s cost basis – whichever is lower.
Inheritance: The basis for inherited stock is usually its value on the date of death of the original owner. Your client, as the recipient of the inheritance, is only responsible for paying taxes on the appreciated value after they took possession of the asset.
Divorce: When property changes hands due to divorce, the waters can get muddy. When assets are transferred during a divorce, the basis of the original owner is transferred as well. The catch is that the new owner is then responsible for taxes before and after the transfer.
Where Does 1099-DIV Box 3 Non-Dividend Distributions Show On the Form 1040?
Non-dividend distributions do not need to be reported anywhere on your client’s tax return because they are treated as a “return of capital” and are not taxable in most cases. The information in Box 3 should be used by your client to reduce the cost basis for his or her own records, but it will not be entered on their Form 1040.