# cost basis PM taxes

can someone clear this for me? not familiar with american tax laws. what exactly is it? it says purchase price plus transaction costs in investopedia… but what does that have to do with taxes… in term (1+r)^n(1-t cap gain) + tB

If you invest \$10,000 and pay a \$10 commission then your cost basis is \$10,010. If you sell the investment for \$11,000, then you are taxed on the cap gain (\$11,000 - \$10,010 = \$990 cap gain). Multiply the cap gain by the tax rate and you have your tax liability.

because transaction fees are tax deductible?

Yeah, but I don’t get the sense they care to ask us about the relationship between transaction fees and cost basis. I think the main purpose is for evaluating the FVIFs going forward on investments for which the cost basis is below current value. For example, suppose you inherit \$150,000 worth of stock from your folks, but they bought the stock for \$80,000 several years ago. So when you go to sell the stock, you’ll be paying tax on the capital gain, which would be the selling price minus \$80,000, as opposed to the selling price minus \$150K. This reduces your tax burden (since cost basis is not taxed), but by less than if you had a cost basis equal to the current market value. Hence the “+TB” term in those FVIF formulas.

honestly the whole basis idea confused me a lot. i still dont understand, if you invest \$1000, why it matters that the orginial price was \$750. i just accept it for what it is and if it says that basis is \$750 i multiply the last term by 0.75. cant win em all.

NY–it’s b/c Schweser does a poor job of explaining. If you are reviewing the examples that build on each other starting on page 317, then I see the confusion. But, consider that the first couple of examples are not assuming any cost basis (b/c cost basis isn’t an issue in accrual taxes). See below… Realized capital gains isn’t discussed until page 319 and then they tell us that the investment was purchased for \$750 originally (again the purchase price just simply didn’t matter in accrual taxation). Think of that \$1,000,0000 you have invested making 10%. You have taxable income of \$100,000 (the basis is irrelevant). The accrual taxation is taking into account divs and int during the life of the investment. Cost basis comes into play when you sell the investment. I just checked out the CFAI book and it is explained a little better than Schweser (the book actually mentions “realized gain.”

planner, you’re a life saver. sounds like u are used to tax planning. thanks.

still not following. you invested 1,000. what does the 750 represent then? if you are saying that the investment was “purchased for 750 originally” that to me sounds like you spent 750, which means the fvif should be multupled by 750—instead the fvif is multiplped by 1000 and the last term is multuipled by .75. i dont see where the 1000 comes from if you spent 750 originially

Think of it as a fixed asset purchase in accounting. When you purchase, you can capitalize the cost of installation and transportation … therefore your assets are both capitalized cost and the asset. Cost basis in accounting is Historical “real” cost so when you calculate CAP Gain = proceeds - (asset price + capitalized costs - accum depreciation) thats all i can understand from this. As for why we need to know a separate formula for something like this is beyond my understanding.

unbelievable

Let me try again. If you bought the investment in 1990 at \$750, you might still want to know the return in say, 2008. So, in 01/01/2008 the value of the investment was worth \$1,000 and paid a dividend of \$10 during the year. You compute your accrual taxes on the div and you are still holding the investment at 12/31/08. The cost basis has nothing to do with your accrual return (or whatever in 2008). You sell your investment in 2009. It is still worth \$1,000, but now the cost basis comes into play. You need to know your after tax return. So, you need to reduce your return by the amount of tax on \$250. Or, for the matter of the test you may not even realize the gains of \$250 (\$1,000 less the cost basis of \$750), but you simply want to know the after tax return including the basis. It’s real life. The cost basis matters in real life only if you sell.