Series 65

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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
    ß-----------------------$60---------------------------------------$70-------------------------à
    Taxable loss | Neither loss nor gain | Taxable gain


    Netting Capital Gains and Losses and Wash Sales
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