Lesson 3 of 6
Cost basis
Basis is what you paid, adjusted. A 4-for-1 split leaves the total unchanged; a return of capital reduces it. Both are in the filings.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Basis is what a holding cost, including commissions, adjusted for everything that has happened to it since.
- A split changes the basis per share and leaves the total unchanged. A return of capital distribution reduces the total.
- Where several lots of the same holding exist, which lot is treated as sold is a choice with consequences, and it has to be made at the sale.
A gain is a sale price minus a basis. Half of the attention goes to the sale price, which is a quote anyone can see, and almost none to the basis, which is a number that has been changing quietly since the day of purchase.
What a 4-for-1 split did to one holding
Before the split
19 July 2021
100 shares. Assumed basis of 50 a share. Total basis 5,000.
After the split
4-for-1
400 shares. Basis of 12.50 a share. Total basis 5,000.
Four times the shares, a quarter of the basis each, the same 5,000 in total.
What goes into it
Basis starts as the purchase price plus the costs of buying: commissions and fees paid to acquire the holding. It is not the price on the screen at the time and it is not the current value.
Then it moves. Three things move it, and only one of them is obvious.
A split does not change the total
A split multiplies the share count and divides the basis per share. Nothing is gained and nothing is realised. The figure above is a real one: NVIDIA's 10-K for fiscal 2022 reports a stock split conversion ratio of 4, effective 19 July 2021. A holder of 100 shares held 400 the next day, and the total basis was the same number it had been.
This matters mostly for reading history. A per-share figure from before a split and one from after are not comparable until one is restated, and the same applies to a basis carried in a spreadsheet.
A return of capital reduces it
This is the one that catches people, and there is a real filed example.
The general point is the one that survives every change in the rules: a distribution that looks identical in a brokerage statement can be a dividend or a return of capital, and the difference is stated in a company filing rather than in the statement.
Which lot did you sell
An investor who bought the same company three times holds three lots with three bases. Selling part of the position requires deciding which lot went.
The default in the US is first in, first out, which sells the oldest lot. Other identification methods exist and generally have to be specified at or before the sale rather than reconstructed afterwards. The choice changes the reported gain and, because the lots have different purchase dates, it can change the holding period too.
What follows from that is a record-keeping point rather than a strategy: the purchase date and cost of each lot is information that has to be kept, because recovering it later from a statement is unreliable.
Check yourself
A 4-for-1 split turns 100 shares with a total basis of 5,000 into what?
- 400 shares with a total basis of 20,000
- 400 shares with a total basis of 5,000, or 12.50 each
- 400 shares with a total basis of 1,250
Show the answer
Answer: B.
A split divides the basis per share by the ratio and multiplies the share count by it. The total is untouched because nothing was bought, sold or received.A company announces that a distribution was a return of capital. What happens to a holder's basis?
- It rises
- It falls, which increases the gain on an eventual sale
- It is unchanged, since cash was received
Show the answer
Answer: B.
A return of capital is treated as a return of the shareholder's own investment rather than as income. It reduces basis, which means more gain is realised when the holding is eventually sold.You hold three lots of the same company bought on different dates. Why does it matter which one you sell?
- It does not, the shares are identical
- The lots have different bases and different purchase dates, so the gain and the holding period both change
- Only the oldest lot may be sold
Show the answer
Answer: B.
The shares are identical, the tax records attached to them are not. Different bases give different gains, and different purchase dates can place the sale on different sides of the holding-period line.Sources
- NVIDIA Corporation, annual report on Form 10-K for fiscal 2022, accession 0001045810-22-000036, filed 18 March 2022: stock split conversion ratio of 4, dated 19 July 2021, as filed in XBRL.
- American Software, Inc, current report on Form 8-K, exhibit EX-99.1, accession 0001628280-21-000684, filed 20 January 2021: the announcement that certain 2020 distributions were return of capital, non-dividend distributions affecting shareholders' basis, and the reference to Form 8937, Report of Organizational Actions Affecting Basis of Securities.
- IRS Publication 551, Basis of Assets, and IRS Publication 550, Investment Income and Expenses: the general treatment of basis and its adjustments.
What this leaves out
- This is not tax advice. It describes general US mechanics. Rules differ by country, by state, by account type and by individual circumstance, and they change.
- The 50 a share cost and the 100-share holding are illustrative. Only the split ratio and its date come from a filing.
- Lot identification rules, their deadlines and what a broker reports differ by broker and by account. Confirm the current rules or ask a qualified adviser rather than relying on the default described here.
- The American Software filing is used because it is a real, public example of a company announcing a basis adjustment. Nothing here is a statement about that company.
- Nothing here is advice about any security.