Cost Basis

The original value of an asset for tax purposes — typically what you paid for it, including any income already recognized on it. Cost basis is subtracted from sale proceeds to calculate your taxable capital gain or loss.

Cost basis is the value assigned to an asset for the purpose of calculating capital gains or losses when the asset is sold. In the simplest case — buying a stock on the open market — your cost basis is the purchase price plus any commissions or fees. When you sell the asset, your taxable gain or loss is the difference between the sale proceeds and your cost basis: a $10,000 sale on an asset with a $7,000 basis produces a $3,000 capital gain; the same sale on an asset with a $12,000 basis produces a $2,000 capital loss. Getting cost basis right is essential for accurate tax reporting — errors in basis are one of the most common causes of overpaying taxes on investment gains.

Cost basis becomes more complex with equity compensation because shares are often acquired in pieces at different prices, and some of those acquisitions generate ordinary income that is already taxed before any capital gain calculation applies. For RSUs, the cost basis of the shares is the fair market value at the time of vesting — this is the amount included in your W-2 as ordinary income. If your RSUs vest at $40/share and you later sell at $55/share, your basis is $40 and your capital gain is $15/share. If you incorrectly use $0 as your basis (the price you 'paid' out of pocket), you'd report a $55/share gain and pay taxes on $40 that was already taxed as ordinary income — double taxation.

For stock options, cost basis depends on the option type and timing. For NSOs, the cost basis of the acquired shares equals the exercise price plus the spread recognized as ordinary income at exercise (the full fair market value at exercise). For ISOs in a qualifying disposition, the cost basis is simply the exercise price — the ISO tax benefit means no ordinary income was recognized at exercise. For ESPP shares, basis calculation involves the discount element and whether the sale is qualifying or disqualifying. In all cases, the key principle is that cost basis includes any amount already subjected to income tax — it represents the after-tax starting point for the capital gain calculation.

Tracking cost basis across multiple lots of the same stock — acquired through purchases, vesting, and option exercises at different prices and dates — requires deliberate record-keeping. Brokers are required to report cost basis to the IRS on Form 1099-B for 'covered securities' (stocks acquired after 2011), but they may not always have accurate basis information for equity compensation shares, especially if shares were transferred from a company equity platform to a personal brokerage account. Employees should maintain their own basis records — grant agreements, vest confirmations, exercise receipts — and verify against broker-reported basis at tax time. Discrepancies, especially on RSU and option shares, are common and almost always result in basis being understated (and gains being overstated) if the broker's records are used uncritically.

Cost Basis by Equity Compensation Type

  • RSUs: basis = FMV at vest date (the amount included as ordinary income on your W-2). If you sell immediately at vesting, there's typically no capital gain — basis equals proceeds. If you hold and sell later, the gain/loss is measured from the vest-date FMV.
  • NSOs: basis = exercise price + spread recognized as ordinary income at exercise = FMV at exercise. Subsequent appreciation above FMV-at-exercise is capital gain.
  • ISOs (qualifying disposition): basis = exercise price only. The entire gain from exercise price to sale price is capital gain — the ISO benefit. No ordinary income component at exercise (for regular tax purposes).
  • ISOs (disqualifying disposition): basis = exercise price + spread treated as ordinary income = FMV at exercise. Same result as NSOs.
  • ESPP (qualifying disposition): basis = the lower of FMV at offering start or FMV at purchase, adjusted for any discount element that must be treated as ordinary income. Complex — verify with the specific plan document.
  • Purchased shares: basis = purchase price + commissions.

Specific Identification vs. FIFO vs. Average Cost

When you hold multiple lots of the same stock acquired at different times and prices, you need a method for determining which lot you're selling when you sell a partial position. Three common methods: (1) FIFO (First In, First Out): the default for most brokers — shares purchased earliest are sold first. (2) Specific Identification: you choose which lot to sell — useful for tax optimization, such as selecting high-basis lots to minimize gains or selecting lots held over a year to qualify for long-term rates. (3) Average Cost: averages the basis across all lots — simple but removes flexibility. Specific identification is the most tax-efficient method if used thoughtfully, but you must designate the specific lot at the time of sale — you cannot retroactively choose after the sale is complete. Most brokerage platforms support specific identification with a few clicks at time of sale.

When Broker-Reported Basis Is Wrong

  • RSU shares transferred from equity platform to personal brokerage: brokers sometimes receive shares with a $0 basis if the equity platform didn't transmit basis information — always verify.
  • Shares acquired before covered security rules (pre-2011): brokers may have no basis information for older holdings.
  • Reinvested dividends: each dividend reinvestment creates a new lot with its own basis — brokers track this but it's worth verifying over long periods.
  • Wash sales: a wash sale triggers a basis adjustment on replacement shares — brokers are required to track this for covered securities but may miss cross-account wash sales.
  • What to do: compare your records to the 1099-B before filing. If broker-reported basis is wrong, you can correct it on Form 8949 — but you need your own documentation to support the correction.

Example

An engineer has 500 RSU shares that vested at $45/share — $22,500 included as ordinary income on her W-2 that year. Her cost basis in those shares is $45 each. Two years later she sells all 500 shares at $70. Her broker's 1099-B shows proceeds of $35,000 but lists her cost basis as $0 (the shares were transferred from the equity platform and basis wasn't transmitted). If she files using the $0 basis, she'll report a $35,000 capital gain — paying capital gains tax on $22,500 of income that was already taxed as ordinary income. She corrects the 1099-B on her Form 8949 to reflect the $45 basis, reporting only a $12,500 long-term capital gain. The $22,500 in ordinary income was already reported on her W-2 two years earlier.