Cost Basis vs. Account Balance: Why They Are Different

Investors reviewing a brokerage statement often find two different figures for their investment’s value: “cost basis” and “account balance,” also known as “market value.” The discrepancy exists because each number serves a distinct function. Understanding the difference between cost basis and account balance is necessary for tracking an investment’s performance and managing tax obligations. This article will clarify what each term means and the purpose it serves.

Defining Cost Basis

Cost basis is the original value of an asset for tax purposes, serving as the starting point for calculating capital gains or losses upon sale. The calculation is the amount paid to purchase a security, plus any associated transaction costs like brokerage commissions or transfer fees. For example, if you purchase 100 shares of stock at $50 per share and pay a $10 commission, your total cost basis is $5,010. This is the figure used to determine your taxable gain or loss when you sell the shares.

The Internal Revenue Service (IRS) requires you to report the cost basis of securities you sell on Form 8949, which flows to Schedule D of your tax return. Brokerage firms also report this information to you and the IRS on Form 1099-B for covered securities. However, you are ultimately responsible for ensuring the accuracy of the basis reported on your tax return.

Understanding Account Balance

Your account balance, often called “market value,” reflects the current worth of your investments if you were to sell them at the present moment. The calculation is the number of shares you own multiplied by the current market price per share. Following the previous example, if you own 100 shares of stock and the price has risen to $60 per share, your account balance would be $6,000.

This figure provides a real-time snapshot of your investment’s performance and is the value most investors watch to see how their portfolio is growing or shrinking. The value is dynamic, changing with market fluctuations, and its purpose is informational, helping you make decisions about whether to buy, sell, or hold your positions.

The Relationship Between Cost Basis and Account Balance

The difference between your cost basis and account balance is your “unrealized gain” or “unrealized loss.” This gain or loss exists only on paper and has no immediate tax consequences until you sell the asset. The relationship can be expressed as: Account Balance = Cost Basis + Unrealized Gain/Loss. Using our continuing example, with a cost basis of $5,010 and an account balance of $6,000, the $990 difference is your unrealized gain. If the stock price dropped to $40 per share, your account balance would be $4,000, resulting in an unrealized loss of $1,010.

This unrealized figure becomes a “realized” gain or loss once you sell the security, which is when tax implications arise. A realized gain may be subject to capital gains tax, while a realized loss can often be used to offset other capital gains or a limited amount of ordinary income.

Key Adjustments to Cost Basis

The initial cost basis of an investment is not static, as certain events require adjustments. These adjustments affect the amount of gain or loss you will report for tax purposes, and keeping accurate records is the investor’s responsibility.

Reinvested Dividends and Capital Gains Distributions

If you own stocks or mutual funds and choose to reinvest dividends or capital gains distributions, the reinvested amount increases your total cost basis. For example, if a $100 dividend is used to buy more shares, your cost basis increases by $100. You have already paid income tax on that distribution in the year it was received. Adding it to your basis prevents you from being taxed on it a second time when you sell your shares.

Stock Splits

A stock split changes the number of shares you own and the price per share, but it does not change your total cost basis. For example, if you own 100 shares with a total basis of $1,500 and the company has a 2-for-1 split, you will then own 200 shares. Your total basis remains $1,500, but your per-share basis is now $7.50. You must reallocate your original basis across the new number of shares.

Return of Capital

A return of capital is a payment from a corporation that is not paid from its earnings, but is instead a distribution of your original investment back to you. A return of capital is not taxable in the year received; instead, it reduces your cost basis. If your basis is reduced to zero, any further distributions are treated as a capital gain.

Wash Sales

The wash sale rule prevents investors from claiming a loss on a security if they buy a “substantially identical” security within 30 days before or after the sale. If you trigger this rule, the disallowed loss is not permanently lost. Instead, the amount of the disallowed loss is added to the cost basis of the new replacement shares. This adjustment postpones the tax benefit of the loss until you sell the new shares. For example, if you sell stock for a $500 loss and buy it back within the 61-day window, that $500 loss is added to the basis of the new purchase.