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Understanding cost basis <
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Why cost basis is not performance

A question many investors have about their investments is "How much money did I make?" They often look at cost basis to answer that question. However, cost basis isn't intended to tell you how much money you've made on an investment. Instead, cost basis is used to help determine capital gains or losses for tax purposes.

Investors have the option to purchase shares in an investment by reinvesting interest, dividends, or other distributions. Oftentimes, people consider these distributions to be part of their return. But these distributions are added to the cost basis when they're reinvested. Although money was earned on the original investment by way of a distribution, it's not considered part of the performance.

As a hypothetical example, let's say you invest $10,000 in Mutual Fund A and $10,000 in Mutual Fund B on the same day. The $10,000 investment is the original cost basis for each fund. (Figure 1)

Figure 1: Beginning balances
 Mutual Fund AMutual Fund B
Initial investment$10,000$10,000
Price/share$10$10
Shares1,0001,000
Cost basis$10,000$10,000

During the first year, Mutual Fund A increases $1,000 due to market changes, and ends with a balance of $11,000. Mutual Fund B earns $1,000 in dividends that are reinvested, and also ends with a balance of $11,000. (Figure 2) Here's where cost basis and personal performance differ.

Figure 2: Account activity
 Mutual Fund AMutual Fund B
Initial investment$10,000$10,000
Increase due to market appreciation$1,000$0
Dividends paid and reinvested$0$1,000
Dividend reinvestment price/sharen/a$10
Dividend reinvestment shares0100
End of year account value$11,000$11,000

At the end of the year, Mutual Fund A still has a cost basis of $10,000, but since the fund increased due to the market there's a gain of $1,000.

Now let's look at Mutual Fund B. At the end of the first year the cost basis of this fund is $11,000, so when looking at the value of the investment it shows there's no gain. (Figure 3)

Figure 3: Ending balances
 Mutual Fund AMutual Fund B
Account value$11,000$11,000
Price/share$11$10
Shares1,0001,100
Cost basis$10,000$11,000
Unrealized appreciation+$1,000$0
Total investment returns+$1,000$1,000

Why the difference? In Mutual Fund B, income was distributed and used to purchase more shares. These reinvestments are treated the same as any other investment you would make in the fund. So your basis increases, even though you didn't actually put any new money into the investment.

In the end, look at your cost basis information to help you figure out the tax consequences of selling an investment. If you want to know how much money you've made or lost in an investment, look at your personal performance.

This hypothetical example does not represent any particular investment.

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Because of regulatory changes affecting the reporting of cost basis information to the IRS, we've put together a variety of resources here to help you understand what cost basis is, make it easier to select an appropriate method for your tax situation, and navigate any changes in tax filing.

What is cost basis?

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Cost basis is, generally, the price you paid for your shares. This includes adjustments such as reinvested dividends and capital gains, as well as any sales commissions or transaction fees.

A question many investors have about their investments is "How much money did I make?" They often look at cost basis to answer that question. However, cost basis isn't intended to tell you how much money you've made on an investment. Instead, cost basis is used to help determine capital gains or losses for tax purposes. Learn more about why cost basis is not performance

The importance of reporting accurate cost basis information

Keeping track of your cost basis is an important step in determining your capital gains or losses on sales of shares. The IRS requires you to report your gains or losses for shares sold when you file your annual tax return.

Because of regulatory changes, which are being phased in over five years, investment companies such as Vanguard are reporting cost basis for sales in taxable (nonretirement) accounts to the IRS as well as to you. Previously we reported this information only to you. The table below lists the effective dates for the different types of securities that are covered by the new IRS rules. If you acquire shares after the effective date and subsequently sell them, your cost basis will be reported to the IRS as well as to you.

Timetable of cost basis legislation changes

January 1, 2011 January 1, 2012 January 1, 2014 January 1, 2016
Stocks Mutual funds* Less complex bondsMore complex bonds
Certain ETFs** Most ETFs*** Most optionsCertain options involving more complex bonds
  Dividend reinvestment plans (DRiPs)    

*Excluding money market funds.

**ETFs that are unit investment trusts (UITs) and taxed as regulated investment companies. If you're not sure whether this applies to your ETF, check with your issuer.

***Certain ETFs, such as those that invest in commodities, aren't stocks; therefore, they're not covered under the regulations.

Generally, these are bonds or other debt obligations with fixed yield and maturity dates.

Generally, these are bonds or other debt obligations without fixed yield and maturity dates.

 
 
 
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