One of the simplest methods of calculating cost basis is average cost. This is Janus Henderson's default method of calculating your gains or losses and ultimately helps you determine what is taxable when you sell or exchange shares.
You’ll typically need to calculate cost basis for taxable accounts. Retirement or tax-deferred accounts offer tax shelters and therefore are generally taxed in different ways.
What is the average cost basis method?
The average cost basis method considers the total cost of your investment, factoring in purchases, reinvested dividends, capital gains and returns of capital. From that figure, it calculates the average purchase price of your shares. Your average cost basis can help you calculate whether or not your investment gained or lost value.
Average cost isn’t the only method to calculate cost basis. Unless you elect an alternative, the average cost method is used help calculate the money you made (or lost) and how much you owe in taxes.
Cost basis determines gains or losses
When you sell a share, the net proceeds from the sale are compared to your average cost basis. If your net proceeds are greater than the average cost basis, then the sale is generally considered a gain. If it’s less than what you paid for it, it may be a loss.
Example: average cost basis calculation
A shareholder opens an account with a $2,500 initial purchase and invests $100 into the same fund at different times during the same year. Then the fund paid a taxable capital gain distribution of $50, which was reinvested into the fund. The result is an addition to the cost basis of $50.
| Date | Transaction | Cost Per Share | Average Cost Basis (Total Purchase ) | Number of Shares |
|---|---|---|---|---|
| June 1 | Purchase | $50 | $2,500 | 50 |
| Sept. 1 | Purchase | $35 | $100 | 2.86 |
| Oct. 1 | Purchase | $40 | $100 | 2.5 |
| Dec. 15 | Capital gain reinvested | $40 | $50 | 1.25 |
| Totals | $2,750 | 56.61 |
The same shareholder sold five shares the following year on May 1 at $70 per share for a total sale of $350.
| Date | Transaction | Cost Per Share | Net Proceeds | Number of Shares |
|---|---|---|---|---|
| May 1 | Redemption | $70 | $350 | 5 |
Average Cost per share = Total purchases ($2,750) ÷ total number of shares owned (56.61) = $48.58.
To calculate the average cost, divide the total purchase amount ($2,750) by the number of shares purchased (56.61) to figure the average cost per share = $48.58.
Cost Basis = Average cost per share ($48.58) x # of shares sold (5) = $242.90.
The difference between net proceeds of the sale and the cost basis in this example indicates a gain of $107.10. Remember, average cost sells the oldest shares first.
Gain or Loss = Net Proceeds ($350) - Cost Basis ($242.90) = Gain of $107.10.
How does average cost impact taxes?
When shares are sold, average cost helps you determine what is taxable and what is not. Gains are generally taxable and losses are typically not.
In the year after a sale, you will receive Form 1099-B, which reports net gains or losses for taxable accounts.
Short-term gains are generally taxed at your ordinary income rate. Long-term capital gains are taxed at a rate typically lower than the ordinary income tax rate.
Short- or long-term gains are determined by how long you’ve owned the shares. Shares held for a period of more than one year are generally considered long term – a year or less is generally considered short term.
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