Finding the cost basis for a stock or other security is often needed in order to report the gain or loss on that security when it is sold. If an investor buys a security, the cost basis for that security is they money he spent to buy it, along with any commissions or fees he had to pay in addition to that cost. The whole cost out of pocket for the investor and not just the cost of the shares is the cost basis on that purchase. Over the course of time if the investor accumulates many shares of many different stocks, the cost basis for any and all of those stocks would still be the cost of the stock he paid to buy them plus the commissions he paid to a broker in order to get his hands on them.
Investors who are given a security rather than acquiring it by buying it have a different cost basis. If the shares are given away at a loss to the donor, the fair market value of the securities on the date of the gift must be used to determine the costs basis. In other words, the price the stock in question was selling for on that day, multiplied by the number of shares donated, would form the cost basis for a stock donated at a loss. The donor's loss must then be used to determine the recipient's gain when the stock is resold.
If securities are given away at a gain, the cost basis changes once again. In this case, the donor's own cost basis and original acquisition date are used as the recipient's cost basis. Basically by inheriting the security, the investor also inherits its cost basis.
When donated securities are later sold at a loss, the original gift date is used to form the cost basis upon sale. The date when the gift was made is always going to be important information. Investors who receive securities this way should be sure to keep accurate records of these things for future reference when they sell the stock or it otherwise changes hands sometime down the road. Failure to consider this in calculations can be one of the more serious errors in investing.
The acquisition date that must be reported when a stock is resold will depend on the cost basis. If the donor's own costs basis ends up being used, the donor's acquisition date will also need to be used. If the fair market value on the date the stock was given as a gift is used in the cost basis determination, the date the gift was given should be used as the acquisition date and not the donor's date of purchase.
The cost basis when a security is inherited is just the value of that security on the day the person who left it to you died. Whether or not you physically had the security that day does not matter. All that matters is that in the moment the stock's previous owner died, you became the new owner and thus that date becomes the date used to determine cost basis.
Cost basis is important to accurately determine any time securities change hands because these transactions always have the potential to create a capital gains situation. The IRS has very special rules regarding capital gains, especially as they pertain to securities. Knowing how to compute capital gains is very important so that you are sure to pay the correct amount if tax is due. But in order to perform your caluclations correctly, you have to know the cost basis on capital gains first.
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