What Is Cost Basis? Calculation and Tax Examples

Cost basis is generally the starting tax basis of property you purchase. It commonly includes the purchase price plus qualifying costs of acquiring the asset. Cost basis helps determine depreciation while property is used and gain or loss when it is sold.

The word "cost" is important but incomplete. Borrowed money can still be part of an asset's cost, and some closing costs must be added to basis rather than deducted immediately. Later events can change the number, producing adjusted basis.

A basic cost-basis formula

A useful starting formula is:

Purchase price + qualifying acquisition costs = initial cost basis

Qualifying additions can include sales tax, commissions, freight, installation, legal or recording fees connected with acquisition, and other amounts required to buy or place property in service. The rules depend on the asset. Financing charges, property taxes, repairs, and operating costs do not all receive the same treatment.

Cost basis example

Assume a business buys equipment for $40,000. It pays $2,000 for delivery and installation and $500 for a required setup charge.

$40,000 purchase price + $2,000 delivery and installation + $500 setup = $42,500 cost basis

If the business later claims $17,500 of depreciation, its adjusted basis is generally:

$42,500 − $17,500 = $25,000 adjusted basis

If it sells the equipment for $30,000, the simplified gain is $5,000. Depreciation recapture and other character rules may affect how that gain is taxed.

Cost basis for investments

For a purchased stock, bond, mutual fund, exchange-traded fund, or digital asset, cost basis generally begins with the amount paid plus applicable transaction costs. Reinvested dividends or capital-gain distributions usually purchase additional shares with their own basis; they are not "free shares."

When multiple lots are sold, the permitted identification method matters. Specific identification can select documented lots. FIFO generally treats the oldest shares as sold first when no valid identification is made. Average-basis rules may be available for certain regulated investment company shares. Brokerage reporting helps, but the taxpayer remains responsible for an accurate return.

Corporate actions can complicate the calculation. Stock splits change per-share basis without changing total basis. Mergers, spin-offs, return-of-capital distributions, wash sales, bond premium or discount, and inherited or gifted property require additional analysis.

Cost basis for real estate

Purchased real estate generally begins with purchase price plus qualifying acquisition costs. The total must then be allocated among land, buildings, and other identifiable assets. Land is not depreciable; buildings and certain improvements may be.

Assume a rental property costs $500,000 and a supportable allocation assigns $100,000 to land and $400,000 to the building. If $5,000 of capitalized acquisition costs belongs to the building, its initial depreciable basis is $405,000. The land basis remains separate.

Mortgage principal does not create a current rental deduction, and the outstanding loan balance is not the property's basis. Refinancing generally does not reset basis. Improvements can increase basis later, while depreciation reduces adjusted basis.

Cost basis vs. tax basis and adjusted basis

Cost basis is usually the starting basis of purchased property. Tax basis is the broader concept that also covers property received by gift, inheritance, exchange, contribution, conversion, or another method. Adjusted basis is the starting basis after applicable increases and decreases.

These distinctions matter because not every asset starts with cost. Gifted property can use carryover and dual-basis rules. Inherited property is generally based on estate-tax value or fair market value at death, subject to exceptions. Property converted from personal use can have a depreciation basis limited by fair market value.

Where cost basis appears on a tax return

Basis can affect several forms:

• Form 8949 and Schedule D for many capital-asset sales
• Form 4797 for sales of business property
• Form 4562 and depreciation schedules for business or rental assets
• Schedule E for rental depreciation and disposition-related amounts
• Partnership and S-corporation owner-basis schedules

A broker's Form 1099-B may show basis as reported or not reported to the IRS. Form 8949 can be used to reconcile or adjust reported amounts when the taxpayer has support.

Federal and California treatment

California often follows the federal starting cost of an asset, but later federal and state basis can differ. California does not conform to federal bonus depreciation and has substantially different Section 179 limits. As a result, the same equipment can have one federal adjusted basis and another California adjusted basis.

Different depreciation deductions can later create different California gain or loss on sale. Taxpayers should retain parallel federal and California asset schedules rather than reconstruct the difference years later.

Common mistakes

• Using the loan balance or down payment as basis
• Treating market value as cost basis for purchased property
• Omitting commissions, installation, or qualifying acquisition costs
• Deducting a capital improvement as a repair
• Forgetting reinvested dividends and additional investment lots
• Using original cost after depreciation or return-of-capital adjustments
• Assuming the broker knows every pre-transfer or inherited basis item
• Combining land and building basis for depreciation
• Using federal adjusted basis for California without checking differences

Records to keep

Keep purchase agreements, escrow statements, invoices, brokerage confirmations, trade history, reinvestment records, corporate-action notices, improvement invoices, depreciation schedules, prior returns, Forms 1099-B, gift records, and date-of-death appraisals. Basis records should generally be retained for as long as the asset is owned and through the limitations period after its final tax effect.

Frequently asked questions

Related terms

• Tax Basis
• Adjusted Basis
• Depreciation
• Capital Improvement
• Form 8949
• Depreciation Recapture

Official sources

• IRS — Topic No. 703, Basis of Assets
• IRS — Publication 551, Basis of Assets
• IRS — About Form 8949
• California FTB — Depreciation and amortization
• California FTB — 2025 Schedule CA (540) instructions

The definitions and examples on this page are for informational purposes only and do not constitute tax advice. Tax laws change frequently and individual circumstances vary. Consult a qualified tax professional before making decisions based on this content.