Taxation Issues - Holding Period and Cost Basis

Since the difference between short- and long-term capital gains taxation rates is so significant, you need to understand exactly when a security is considered purchased and when it is considered sold.

  • The holding period begins the day after the security is purchased (not the settlement date).
  • The holding period ends the day of the sale.
  • It is important to keep detailed records of these dates, to ensure that a security is not sold too soon and thus qualifies for preferential tax treatment.

Cost Basis
Merely knowing the tax rates is not enough for an investment adviser. A key concept to understand is cost basis, since the amount of capital gains to be taxed is calculated by subtracting the investor's cost from the sales proceeds. To determine the cost basis of an investment, start with the original price (plus any transaction costs). Next, add the dollar value of dividends that were reinvested. This would apply to both stocks in a dividend-reinvestment program and mutual funds where dividends are automatically reinvested. Reinvested capital gains are also added to the cost basis for mutual funds.

Cost basis = Original Price + transaction costs + reinvested dividends

  • If you inherit an investment
, your cost basis is the value of the asset as of the decedent's date of death. This is known as a stepped-up cost basis. Also, the holding period is always considered long term, even if the deceased hadn't owned the investment for 12 months before death.

  • If you receive an investment as a gift, there are actually two different cost bases that apply:
  • 1 - The actual cost basis of the giver; and
    2 - The market value on the date of the gift.

    1. The actual cost basis of the giver transfers to the receiver if the value of the asset is equal to or greater than what the giver first paid for it. This is known as carryover basis.

    2. The market value on the date of the gift comes into play if the investment had declined in value since the giver acquired it. For "loss property", there is what is known as double basis. The best way to explain how this works is to use an example. Let's say you are given shares of stock, and the original owner's cost basis was $70 a share. On the date of the gift, the shares are trading at $60. If you sell the shares in the future, the basis for a gain is $70 a share, and the basis for a loss is $60. If you sell the shares for a price between $60 and $70, you have neither a taxable gain nor a taxable loss. See the illustration below.

    Value on date of gift Value at purchase
    Taxable loss | Neither loss nor gain | Taxable gain

    Netting Capital Gains and Losses and Wash Sales
    Related Articles
    1. Professionals

      Career Advice: Financial Analyst Vs. Investment Banker

      Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
    2. Professionals

      Who Needs to Take the Series 65?

      Most states require individuals to pass the Series 65 exam in order to act as investment advisors.
    3. Personal Finance

      RIAs and Brokers: What's the Difference?

      RIAs and brokers are held to different standards when providing investment advice. Here's how they differ.
    4. Investing Basics

      Brokers and RIAs: One and the Same?

      Brokers and registered investment advisors have some key differences. Here's what you need to know.
    5. Professionals

      Understanding Series 6

      Upon successful completion of the Series 6, an individual will have the qualifications needed to sell open end mutual funds and variable annuities
    6. Professionals

      Top Strategies on How to Become a Stock Broker

      Gunning to be a stock broker and want an edge? Here's some veteran advice.
    7. Trading Systems & Software

      Steps to Starting Up an Independent Broker Dealer

      Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
    8. Professionals

      Understanding Series 63

      Series 63 is a securities license that entitles the holder to sell securities in a particular state.
    9. Professionals

      How To Answer Option Questions On The Series 7 Exam

      Learn how to answer option questions on the Series 7 exam. Pass your Series 7 exam with the help of these tips.
    10. Insurance

      Municipal Bond Tips For The Series 7 Exam

      Learn to distinguish between general obligation and revenue bonds to ace this test.
    1. Series 6

      A securities license entitling the holder to register as a limited ...
    2. Series 79

      A examination to ensure a candidate is qualified to become a ...
    3. Research Analyst

      A person who prepares investigative reports on equity securities. ...
    4. Series 34

      An exam required for individuals seeking to engage in off-exchange ...
    5. Financial Advisor

      One who provides financial advice or guidance to customers for ...
    6. Series 23

      An exam offered by the Financial Industry Regulatory Authority ...
    1. Is a financial advisor required to have a degree?

      Financial advisors are not required to have university degrees. However, they are required to pass certain exams administered ... Read Full Answer >>
    2. Do financial advisors have to be licensed?

      Financial advisors must possess various securities licenses in order to sell investment products. The specific products an ... Read Full Answer >>
    3. If I have only a limited amount of time to study for the Series 6, what should I ...

      The Series 6 Investment Company and Variable Contracts Products Representative Qualification Examination is administered ... Read Full Answer >>
    4. What role does the 'chip cycle' play in the electronics sector?

      There are several highly acclaimed private Series 6 Exam courses in the United States. Many can be completed online. Popular ... Read Full Answer >>
    5. What does passing the Series 6 enable me to do?

      The Series 6, or the Investment Company Products/Variable Contracts Limited Representative, exam is administered by the Financial ... Read Full Answer >>
    6. What are the differences between the Series 6 exam and the Series 7 exam?

      The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
    Hot Definitions
    1. Ex Works (EXW)

      An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
    2. Letter of Intent - LOI

      A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
    3. Purchasing Power

      The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
    4. Real Estate Investment Trust - REIT

      A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
    5. Section 1231 Property

      A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
    6. Term Deposit

      A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
    Trading Center
    You are using adblocking software

    Want access to all of Investopedia? Add us to your “whitelist”
    so you'll never miss a feature!