What is an adjusted cost basis and how is it calculated?

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.

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Cost Basis Basics

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 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 in future years. 

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  1. Internal Revenue Service. "Publication 551: Basis of Assets," Page 2.

  2. Internal Revenue Service. "Topic. No. 703: Basis of Assets."

  3. Internal Revenue Service. "Publication 551: Basis of Assets," Pages 2-5.

  4. Internal Revenue Service. "Publication 551: Basis of Assets," Pages 5-6.

  5. Internal Revenue Service. "Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)," Pages 66-67.

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