Calculate cost basis of stock options

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

Investopedia.

The cost basis of any investment is the original value of an asset adjusted for stock splits, dividends and capital distributions. It is used to calculate the capital gain or loss on an investment for tax purposes.

At the most basic level, the cost basis of an investment is just the total amount invested into the company plus any commissions involved in the purchase. This can either be described in terms of the dollar amount of the investment, or the effective per share price that you paid for the investment.

The calculation of cost basis can be complicated, however, due to the many changes that will occur in the financial markets such as splits and takeovers. For the sake of simplicity, we will not include commissions in the following examples, but this can be done simply by adding the commission amount to the investment amount ($10,000 + $100 in commissions = $10,100 cost basis).

Imagine that you invested $10,000 in ABC Inc., which gave you 1,000 shares in the company. The cost basis of the investment is $10,000, but it is more often expressed in terms of a per share basis, so for this investment it would be $10 ($10,000/1,000). After a year has passed, the value of the investment has risen to $15 per share, and you decide to sell. In this case, you will need to know your cost basis to calculate the tax amount for which you are liable. Your investment has risen to $15,000 from $10,000, so you face capital gains tax on the $5,000 ($15 - $10 x 1,000 shares). (For further reading, see A Long-Term Mindset Meets Dreaded Capital Gains Tax and Tax Tips For The Individual Investor .)

If the company splits its shares, this will affect your cost basis per share. Remember, however, that while a split changes an investor's number of shares outstanding, it is a cosmetic change that affects neither the actual value of the original investment, nor the current investment. Continuing with the above example, imagine that the company issued a 2:1 stock split where one old share gets you two new shares. You can calculate you cost basis per share in two ways: First, you can take the original investment amount ($10,000) and divide it by the new amount of shares you hold (2,000 shares) to arrive at the new per share cost basis ($5 $10,000/2,000). The other way is to take your previous cost basis per share ($10) and divide it by the split factor (2:1). So in this case, you would divide $10 by 2 to get to $5. (For more insight, check out Understanding Stock Splits .)

However, if the company's share price has fallen to $5 and you want to invest another $10,000 (2,000 shares) at this discounted price, this will change the total cost basis of your investment in that company. There are several issues that come up when numerous investments have been made. The Internal Revenue Service (IRS) says that if you can identify the shares that have been sold, then their cost basis can be used. For example, if you sell the original 1,000 shares, your cost basis is $10. This is not always easy to do, so if you can't make this identification, the IRS says you need to use a first in, first out (FIFO) method. Therefore, if you were to sell 1,500 shares, the first 1,000 shares would be based on the original or oldest cost basis of $10, followed by 500 shares at a cost basis of $5. This would leave you with 1,500 shares at a cost basis of $5 to be sold at another time.

In the event that the shares were given to you as a gift, your cost basis is the cost basis of the original holder, or the person who gave you the gift. If the shares are trading at a lower price than when the shares were gifted, the lower rate is the cost basis. If the shares were given to you as inheritance, the cost basis of the shares for the inheritor is the current market price of the shares on the date of the original owner's death. There are so many different situations that will affect your cost basis and because of its importance with regards to taxes, if you are in a situation in which your true cost basis is unclear, please consult a financial advisor, accountant or tax lawyer.

Swanger, Rose.

The best way to find out is to review your statement from the investment firm. Starting in tax year 2011, investment firms were required to report the adjusted basis and whether any gain or loss on a sale is classified as short-term or long-term from the sale of "covered securities" on Form 1099-B. This requirement definitely has made everyone’s financial life a little easier. However, it’s still your responsibility to verify the reported data, such as the original purchase price, purchase date, selling price, selling date, etc. The data alone will decide if you qualify for the beneficiary long-term or short-term gains. Best!

Capriotti, Michael.

Calculating cost basis is simple & straight forward. It’s very important to know because you as the investor are responsible to the IRS. The cost basis is what you paid for the stock + the commission. A quick example is you purchase 100 xyz stock $100 and pay the brokerage a $20 commission. Your basis would be $10,020.

Other factors to consider when calculating cost basis are stock splits, dividends & special situations like a gift or inheritance.

If you need additional help, I recommend checking out wwwbasis/. Netbasis’ database of securities information goes back to 1925, and automatically accounts for all splits, mergers & spin-offs.

Itkin, Laurie.

If you inherited the stock, generally the cost basis will be the market price of the stock multiplied by the number of shares on the date the holder died.

If you purchased the stock within the last few years, you should be able to find the cost basis by accessing your account at your brokerage firm. If you can't find it online, you can call.

If you bought the stock many years ago and the company merged or the stock was split, that can be a time-consuming research exercise. You can often find historical stock prices online but you won't get the complete picture.

Hunter, David.

You should look for your original purchase amount plus any subsequent additions. The total cash inflow will be your cost basis.

Sale of Stock from Nonqualified Options.

Tax consequences when you sell stock obtained by exercising a nonqualified stock option.

When you exercise a nonqualified stock option you report ordinary compensation income. But when you sell the stock you report capital gain or loss. Your basis for the stock (used to determine how much gain or loss you report) includes the amount of income you reported for exercising the option, so you don't get taxed twice on the same amount.

Reporting sales of stock.

For many people, a sale of stock from a nonqualified option is the first experience in selling stock. If you aren't familiar with the rules it may appear that the income is being taxed twice. Have no fear, that won't happen.

When you sell stock through a broker you'll receive a form reporting the results of that sale: Form 1099-B. This form does not tell how much gain or loss to report. It merely tells how much you received from the sale. It's up to you to figure how much gain or loss you report from the sale.

To do this you need to know your basis for the stock. Normally your basis for stock is simply your cost for the stock (including brokerage commission, if any). But there's a special rule for stock from nonqualified options.

Basis of your shares.

When you exercise a nonqualified option, your basis is equal to the amount you pay for the shares plus the amount of income you report for exercising the option. In general this means your basis will be equal to the value of the stock on the date you exercised the option.

Example: You exercise a nonqualified option to purchase 1,000 shares of stock for $15 per share when the value of the stock is $40 per share. You report $25,000 of compensation income ($25 per share). Your basis for the shares is $40 per share: $15 you paid plus $25 you reported as income.

Your basis does not include any amount you pay to your employer for tax withholding.

Gain or loss.

Subtract your basis from the amount you received in the sale of your shares to determine your gain or loss. You have a capital loss if the result is a negative number; otherwise you have a capital gain.

Holding period.

It isn't enough to know the amount of your gain or loss. You also need to know your holding period. That lets you know whether your gain or loss is short-term or long-term.

Your holding period for this stock begins when you exercise the option. You can't include the time you held the option. If you sell the stock one year or less after you exercised the option your gain or loss is short-term. You have to wait a year and a day to get long-term gain.

How to Calculate Stock Basis for Exercised Options.

It doesn't require difficult math to compute cost basis.

An option buyer has the right to buy or sell 100 stock shares for a preset price -- the strike price -- on or before expiration date. If the buyer exercises an option, she'll need to know the cost basis of the underlying shares so she'll be able to figure her gain or loss. The stock’s cost basis is the price she paid for the shares and the option, plus commissions.

Call Buyer.

A call option buyer benefits when the underlying stock price goes up. The value of a call is due to the excess of the stock price over the strike price, plus additional “time value” that represents the possibility that the stock price will increase before expiration. The buyer can exercise a call and receive shares at a discount below their current market price. For example, suppose you buy a call for a $200 premium with a strike price of $45 per share, and exercise it when the stock is selling for $48 per share. Discount = 100 shares x ($48 per share current price - $45 per share strike price) = $300. You could then immediately sell the 100 shares for $48 each, or $4,800 sale proceeds, locking in the $300 discount. The cost basis is the strike price per share multiplied by the number of shares, to which you add the call premium and the commission. In this case, cost basis = (100 shares x $45 per share + $200 premium + $7 commission) = $4,707. The gain on the sale = $4,800 sale proceeds - $4,707 cost basis = $93.

Call Seller.

The call seller collects a premium at the time of sale and must stand ready to deliver the underlying shares whenever the stock price exceeds the strike price. When this happens, the options exchange can “assign” the seller, who must then cough up the shares. The cost basis of the shares is whatever the seller shelled out for them. The seller might have purchased the shares before assignment. Otherwise, he’ll have to buy them after assignment. Profit is measured by adding the amount received for selling the shares to the call premium and subtracting the cost basis of the shares and commissions.

A put option buyer hopes that the underlying stock price will fall below the strike price. If this occurs, the buyer can exercise the put and sell the shares to the put seller for the strike value. The buyer normally already owns the shares, and the cost basis is whatever the buyer paid for them, plus commissions. To figure the gain or loss, the buyer subtracts the put premium and the share cost basis from the sale proceeds received for exercising the put.

Put Seller.

The put seller pockets the premium of the put when he sells it. If the stock price falls below the strike price and he is assigned, he’ll have to pay the strike price per share plus a commission. His cost basis is the amount he paid plus commission minus the put premium. For example, if he received a $200 put premium, and then must buy the assigned 100 shares for $4,500 and pay a $7 commission, then his cost basis = ($4,500 share cost + $7 commission - $200 premium) = $4,307. He won’t know what his gain or loss will be until he sells the shares.

References.

About the Author.

Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B. S. in biology and an M. B.A. from New York University. He also holds an M. S. in finance from DePaul University.

Photo Credits.

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Your Cost Basis: How to Calculate It and What It Means.

Don’t ignore your cost bases for your investments, as you will most likely need to know it at some point.

Fortunately, calculating your cost basis is much simpler than this. Photo: Bryan Alexander, Flickr.

If you want to calculate how much you've gained or lost on an investment, you'll need to know your cost basis. It's important for your tax records, too.

Let's run through a very simple example. Imagine that you buy 100 shares of Meteorite Insurance (ticker: HEDSUP) for $50 each, spending $5,000. That's your cost basis. If, a few years later, you sell those 100 shares for $75 each, collecting $7,500, you will realize a gain of $25 per share, or $2,500. You need to know your cost basis to figure out what your profit is on an investment. This is true for all kinds of assets, even houses. If you bought your home for $200,000 and sold it for $250,000, your cost basis (sometimes referred to as a tax basis) is $200,000, and your basic gain $50,000.

If you buy shares of the same stock at different times, you'll want to keep track of your cost basis for each transaction. If you sell some of the shares at some point, you'll be able to specify which shares you sold, thus controlling your reportable gain.

Cost bases can get a little trickier, though, so read on.

When a stock splits, so does your basis.

Pre-split, you had 100 shares, with a basis of $40 per share, for a total initial investment of $4,000. Post-split, you have 200 shares with a basis of $20 per share, for a total initial investment of . $4,000. See? When it comes to the value of your overall holding, nothing has really changed.

If you sell the 200 shares for $15 per share, you'll collect $3,000. Subtract your cost basis of $4,000 from that, and you're looking at a loss of $1,000.

As you might recall, dividends get whacked with their own tax, so if you don't account for them in your cost basis, you're setting yourself up to be taxed on them one more time.

It might look like your taxable gain is $1,000, the result of subtracting your cost basis from your proceeds. But the IRS lets you factor in the cost of the commission. Thus, your purchase price or cost basis is really $5,010, or $50.10 per share. And your proceeds are really $5,990, or $59.90 per share. Subtract $5,010 from $5,990, and you'll get a gain of $980 -- reflecting the two commission charges.

That might seem trivial, but if you have 40 $10 commission charges in the gains or losses that you report in a given tax year, that comes to a total of $400. If you're paying a tax rate of 15% on your long-term gains, you'll avoid paying $60 in taxes on those commissions. If your gains were short-term, taxed at your ordinary income tax rate of, say, 25%, then you'll save $100.

Your cost basis is generally "stepped up" for inherited stock. Photo: Beverly Goodwin, Flickr.

Different rules apply if you receive an asset such as stock as a gift. First off, make sure you ask for and get the gift-giver's cost basis in the stock, as that will probably be your basis when you sell the shares at some point. If you sell and realize a gain, your cost basis is that of the giver's. If you sell and realize a loss, the basis is either the giver's basis or the value of the stock at the time of the gift, whichever is lower.

If you own stock jointly with a spouse who dies, leaving you the shares, you may be able to "step up" the cost basis of half of the shares to the price at the time of death.

Other rules apply to cost bases in different situations, but the rules I've laid out here will apply to most people most of the time.

Don't ignore your cost bases for your investments, as you will most likely need to know them at some point.

Longtime Fool specialist Selena Maranjian , whom you can follow on Twitter , has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter. Follow SelenaMaranjian.