How to Calculate the Cost Basis for an ETF

Cost basis is the original value of an asset for tax purposes, used to calculate the capital gain or loss when you sell your investment. Understanding and accurately tracking the cost basis of your Exchange-Traded Funds (ETFs) is an important part of tax planning. An incorrect basis can lead to paying more tax than necessary.

Determining Your Initial ETF Basis

The starting point for an ETF’s cost basis is its purchase price. This includes the total amount paid for the shares, plus any additional transaction costs like brokerage commissions or trading fees. For instance, if you purchase 100 shares of an ETF at $50 per share and pay a $10 commission, your initial cost basis is $5,010, or $50.10 per share.

The method of acquisition can significantly alter this initial calculation. If you inherit an ETF, the cost basis is “stepped-up” to the fair market value of the shares on the date of the original owner’s death. This means you could inherit shares that were purchased for $20 but are worth $100 on the date of death, and your basis would be $100 per share, effectively erasing the tax liability on the $80 of appreciation.

Receiving an ETF as a gift presents a more complex scenario, as the basis depends on the price you eventually sell it for. Your basis is the same as the donor’s adjusted basis. However, if the ETF’s fair market value (FMV) was lower than the donor’s basis at the time of the gift, special rules apply. If you sell for a gain, you use the donor’s original basis, but if you sell for a loss, you must use the lower FMV from the time of the gift as your basis.

Common Adjustments to ETF Basis

Throughout the time you own an ETF, certain events can change your original cost basis. One of the most frequent adjustments comes from reinvested distributions. Many ETFs distribute dividends and capital gains to their shareholders, who can choose to automatically reinvest them to buy more shares. These distributions are taxable in the year they are received.

The value of each reinvested distribution is added to your cost basis. For example, if you receive a $100 dividend that is automatically used to purchase two additional ETF shares, you will pay tax on that $100 in the current year. Your total cost basis in the ETF will also increase by $100.

Another common adjustment is a nontaxable distribution, a return of capital (ROC). Unlike a dividend, a return of capital is not considered profit or income but rather a return of a portion of your original investment. A return of capital distribution reduces your cost basis in the ETF.

If your initial basis was $5,000 and you receive a $200 ROC distribution, your new adjusted basis becomes $4,800. This reduction will lead to a larger capital gain or a smaller capital loss when you ultimately sell your shares. Your brokerage firm will report the amount of any ROC on Form 1099-DIV.

The Wash Sale Rule and Its Impact on Basis

The wash sale rule is a regulation that can directly affect your ETF’s cost basis and your ability to claim investment losses. This rule prevents investors from claiming a loss on the sale of a security if they purchase a “substantially identical” one within a 61-day window. This window includes the 30 days before the sale, the day of the sale, and the 30 days after the sale.

When a wash sale occurs, the loss you realized on the sale is disallowed for the current tax year. Instead, it is added to the cost basis of the new replacement shares. Additionally, the holding period of the original shares you sold is added to the holding period of the new shares.

For example, imagine you sell 100 shares of an ETF for a $1,000 loss. Ten days later, you repurchase 100 shares of the same ETF. Under the wash sale rule, you cannot claim the $1,000 loss on your tax return, and that disallowed loss is added to the cost basis of the 100 new shares, reducing your future capital gain.

Brokerage statements may not always perform this specific adjustment automatically, especially if the repurchase happens in a different account. The responsibility for adhering to the wash sale rule across all of your accounts ultimately falls on you, the taxpayer.

Reporting ETF Sales for Tax Purposes

When you sell shares of an ETF, the transaction is reported to you and the IRS by your brokerage firm on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” This form details the proceeds from the sale and, in many cases, the cost basis, and you should check whether the securities sold are classified as “covered” or “uncovered.”

For covered securities, which include ETFs purchased on or after January 1, 2011, brokers are required to track and report the cost basis to the IRS. For uncovered securities, those acquired before this date, the broker reports the sales proceeds but may not report the basis. You are solely responsible for calculating and reporting the correct cost basis to the IRS for uncovered securities.

The information from Form 1099-B is used to complete IRS Form 8949, “Sales and Other Dispositions of Capital Assets.” On this form, you will list each sale, reporting the sales price, the cost basis, and any adjustments. You must reconcile the information on Form 8949 with what your broker reported, making corrections to the basis if necessary.

After completing Form 8949, the summary totals for short-term and long-term gains and losses are transferred to Schedule D, “Capital Gains and Losses.” This schedule is attached to your Form 1040 tax return.