The cost basis of an investment or asset is an important consideration in tax planning for individual investors, business owners and heirs receiving inheritances. An investment or asset's cost basis is defined as the amount of the initial investment, or the original purchase price. It is the determinant for the extent to which capital gains tax is assessed and paid once the investment or asset is sold. For highly appreciated assets, such as real estate or individual stocks held for an extended period of time, a lower cost basis results in a much higher tax burden upon the sale of the asset. However, the IRS allows for assets and investments to be adjusted up or down for a number of reasons, resulting in the adjusted cost basis and a reduction in capital gains tax owed. This calculation can be complicated depending on the type of asset and the extent to which additions or deductions are allowed.

Calculating Additions to Cost Basis

The cost basis of an asset or investment may be adjusted up by adding the initial cash basis used to purchase the asset to the costs associated with increasing the value of the asset. These costs can include capital expenses for a business, such as substantial repair or rehabilitation expenses for equipment or facilities. A renovation or room addition can be added to the original cost basis for a homeowner to adjust the amount up. Legal fees associated with the purchase or sale of the asset, title and escrow fees, transfer fees and sales tax may also be used to adjust the cost basis up.

The owner of the asset may also use the costs associated with selling the asset to reach an adjusted cost basis. Common expenses related to the sale of an asset include broker fees, seller commission or costs for shipping the item to a buyer. The addition of these expenses to the original purchase price of the asset results in a higher adjusted cost basis, reducing the amount of capital gains taxes owed at the time of sale.

Calculating Deductions to Cost Basis

Cost basis can also be adjusted down by subtracting any capitalized costs directly correlated to the asset. Common expenses that reduce an asset's cost basis include depreciation, damage to the asset or theft. Depletion or amortization can also be used to adjust the cost basis of an asset down. Business owners have the option of receiving the tax benefit of these deductions at the time of purchase, or at the time of sale. Adjusted cost basis that includes deductions to the value of an asset can be beneficial to investors or business owners when there is a loss on the value of the total investment once the sale occurs. These losses can be used to reduce taxable income up to a certain amount each year, and excess losses can be carried forward for up to three years.

  1. How do I figure out my cost basis on a stock investment?

    The cost basis of any investment is the original value of an asset adjusted for stock splits, dividends and capital distributions. ... Read Answer >>
  2. What are typical examples of capitalized costs within a company?

    Learn examples of capitalized costs such as expenses incurred to put fixed assets to use as well as software development ... Read Answer >>
Related Articles
  1. Investing

    How Depreciation Works on a Rental Property

    One of the advantages of owning rental real estate is the depreciation tax deduction.
  2. Trading

    A Common Base for Understanding Changes in Value

    A discussion of basis points as well as basis point calculations using Excel.
  3. Taxes

    Do You Have to Pay Taxes on Home Sales?

    Taxes are only paid on home sales if your proceeds exceed a certain amount.
  4. Taxes

    Morgan Stanley Tax Mix Up, or Why You Need to Know Your Cost Basis

    Morgan Stanley's error is a reminder to track the cost basis of your investments.
  5. Managing Wealth

    Your Estate: The Best Assets to Leave to Family

    When it comes to estate planning, there are three main factors to consider when distributing assets: liquidity, sentiment and tax planning.
  6. Investing

    The Costs of Investing

  7. Taxes

    An Overview of Itemized Deductions

    Itemized deductions will mostly stay the same for 2017 tax year (medical deductions improve under the new tax bill). Big changes start in 2018.
  8. Taxes

    Making Sense of the 2017 Tax Changes

    Here is a brief overview of some of the changes introduced by the Tax Cuts and Jobs Act of 2017, and how they may affect your taxes.
  9. Taxes

    6 Ways To Write Off Your Car Expenses

    Reduce the cost of owning and maintaining a car with these clever tax tips.
  10. Taxes

    Get Ready For The Estate Tax Phase-Out

    Changes to federal legislation will affect how your assets are treated once you're gone - be prepared.
  1. Adjusted Cost Base (ACB)

    An adjusted cost base is the change in book value of an asset ...
  2. Average Cost Basis Method

    The average cost basis method is a system of calculating the ...
  3. Capital Asset

    A capital asset is a type of asset with a useful life longer ...
  4. Business Asset

    A business asset is a piece of property or equipment purchased ...
  5. Return Of Capital

    Return on capital is that return from an investment that is not ...
  6. Unadjusted Basis

    Unadjusted basis is the original purchase price of an asset, ...
Trading Center