If you sold any of your taxable investments during the year, you must report your capital gain or loss to the IRS on Schedule D.

Calculating your gain or loss begins by knowing the original cost basis of your investment. A capital gain is the difference between the proceeds from selling the investment and your original cost basis. If the cost basis was higher than the proceeds from selling, then you have a capital loss.

You also need to know how long you owned the investment to determine if the IRS considers the gain long or short term. Gains or losses held less than a year are considered short term, while those held over a year are considered long term.  This difference is extremely important as long-term capital gains are taxed at different rate whereas short-term gains are taxed as ordinary income. For both, the precise percentages depend on your tax bracket.

Because cost basis is only used for computing capital gains or losses, it is only required for taxable accounts where gains and losses are taxed. Gains in retirement accounts are not taxed, and therefore knowing the cost basis is usually not required for tax purposes.

Calculating the cost basis requires careful record keeping by you, your custodian, or your investment advisor. The cost basis is not as simple as knowing how much you originally invested.

The cost basis of your original purchase is modified by any additional charges associated with the purchase. If you bought shares of a mutual fund, an individual stock, or exchange traded fund, the brokerage fee you paid for the trade is added to the purchase price, increasing the cost basis. Computing the cost basis for your original purchase might be easy, but adding the cost of reinvested dividends can be a bookkeeping nightmare. You can also get confusing cost basis analysis from share splits, reverse splits, and spin offs of individual stock.

Some investors find that they have investments for which they don’t know the cost basis. What do you do when you can’t compute what you owe in taxes? You make a reasonable estimate. A taxpayer sometimes has to recreate, as best they can, a reasonable guess at what the cost basis is.

Start with what you can remember. Perhaps you know that you purchased the stock some time in 1982, or originally invested $500 in the mutual fund in 1995. You can look up what the stock or mutual fund price was on any day at http://finance.yahoo.com. After entering a specific symbol, view historical prices. From this information, you can usually make an educated guess at the original cost basis. The IRS requires that you make a reasonable effort to compute your cost basis and be able to defend the figures you use. Although you are ultimately responsible, if you do not feel comfortable guessing, you can use a professional to help you estimate the cost basis.

Because it is difficult to reconstruct the necessary records years or decades after the events, it is best to keep accurate records as events unfold. We receive all the transactions in our clients’ accounts on a daily basis. In addition to providing us with timely portfolio information for investments, this also provides us with accurate cost basis information for our clients.

Detailed records of the cost basis for individually purchased lots of shares can be used for additional tax savings. When a portion of an investment is sold, the investor can select which shares were sold. You can sell those shares with the highest cost basis. This will result in the smallest capital gain or the largest capital loss and therefore save money on your taxes. Additionally, when you gift a portion of an investment to charity, you can select which shares were gifted. The shares with the lowest cost basis relieves you from the most gains.

Keeping a careful accounting of your investment’s cost basis isn’t glamorous, but it can help you save time and money when it comes time to sell.

A version of this article was originally published February 16, 2004. Photo by Karl Fredrickson on Unsplash.