Basis

DEFINITION of 'Basis'

1. The variation between the spot price of a deliverable commodity and the relative price of the futures contract for the same actual that has the shortest duration until maturity.

2. A security's basis is the purchase price after commissions or other expenses. Also known as "cost basis" or "tax basis".

3. In the context of IRAs, basis is the after-tax balance in the IRA, which originates from nondeductible IRA contributions and rollover of after-tax amounts. Earnings on these amounts are tax-deferred, similar to earnings on deductible contributions and rollover of pretax amounts.

BREAKING DOWN 'Basis'

1. As there are gaps between spot and relative price until expiry of the nearest contract, the basis is not necessarily accurate. In addition to the deviations created because of the time gap between expiry of the futures contract and the spot commodity, product quality, location of delivery, and the actuals may also vary. In general, the basis is used by investors to gauge the profitability of delivery of cash or the actual, and they also use it to search for arbitrage opportunities.

2. This figure is used to calculate capital gains or losses when a security is eventually sold.

3. Distributions of amounts representing basis in an IRA are tax-free. However, in order to ensure that this tax-free treatment is realized, the taxpayer must file IRS Form 8606 for any year that basis is added to the IRA and for any year that distributions are made from any of the individual's Traditional, SEP and/or SIMPLE IRAs. Failure to file Form 8606 may result in double taxation of these amounts and an IRS-assessed penalty of $50.

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