Cost Basis & Capital Gain Holding Periods
🔑 Numbers, ages & limits
| Item | Exact figure | Notes |
|---|---|---|
| Long-term holding period | Held more than one year — 🔑 the holding period must be one year and one day | Qualifies for long-term rates |
| Short-term holding period | Held one year or less | Ordinary income treatment |
| Long-term capital gain tax rates | 0%, 15%, or 20% depending on annual income | Taxed similarly to qualified dividends |
| Default long-term rate for vague questions | 15% | 📌 Assume 15% when income/rate is unspecified |
| Short-term capital gain tax rate | Investor’s ordinary income tax rate, could be as high as 37% | Similar to non-qualified dividends |
| Capital gains tax form | Form 1099-B (B = brokerage proceeds) | Reported to IRS annually by brokerage firms |
| Net capital gain | Taxes are owed | More gains than losses |
| Net capital loss | Can be used as a deduction | 📌 The chapter states no specific dollar deduction limit or carryforward rule |
| Inherited securities — cost basis | Stepped up to the security’s value on the date of the original owner’s death | — |
| Inherited securities — holding period | Always long-term, regardless of how long the original owner held it | — |
| Gifted securities — cost basis | Recipient takes the original owner’s cost basis | Does not step up |
| Gifted securities — holding period | Does not reset — original holding period carries over | — |
Capital gains & losses — the basics
A capital gain is realized when an investor sells a security for more than its original cost. When you hear “buy low, sell high,” that’s describing a capital gain. If a security is sold for less than its cost, the investor has a capital loss.
A gain or loss is realized when the position is closed (long securities are sold, or short securities are repurchased). To find the gain or loss, investors compare their cost basis to their sales proceeds.
Definitions
| Term | Definition | Example |
|---|---|---|
| Capital gain | > A capital gain is realized when an investor sells a security for more than its original cost. | Buy low, sell high |
| Capital loss | > If a security is sold for less than its cost, the investor has a capital loss. | Negative result of proceeds − basis |
| Cost basis | > Cost basis is the total amount paid to buy the security, including commissions (and other transaction fees). | $50 purchase + $2 commission = $52 |
| Sales proceeds | > Sales proceeds is the total amount received when selling the security, minus commissions. | $70 sale − $2 commission = $68 |
Worked example
An investor purchases shares of ABC stock at $50 while paying a $2 per share commission. Several months later, the stock is sold for $70 while paying another $2 per share commission. What is the cost basis, sales proceeds, and capital gain or loss?
| Item | Result | Reasoning |
|---|---|---|
| Cost basis | $52 | The cost basis equals the purchase price ($50) plus the commission ($2), which is the total amount paid to buy the investment. |
| Sales proceeds | $68 | Sales proceeds equal the sale price ($70) minus the commission ($2), which is the total amount received from selling the investment. |
| Capital gain or loss | $16 capital gain | Subtract cost basis from sales proceeds: $68 − $52 = $16. A positive number is a capital gain; a negative number is a capital loss. |
⚠️ Long-term vs. short-term capital gains
| Feature | Long-term capital gain | Short-term capital gain |
|---|---|---|
| Holding period | Securities held more than one year (must be one year and one day) | Securities held one year or less |
| Tax rate | 0%, 15%, or 20%, depending on annual income | Investor’s ordinary income tax rate — as high as 37% |
| Analogous to | Qualified dividends | Non-qualified dividends |
| Vague-question default | Assume 15% | Use the investor’s stated income tax bracket |
Sidenote — Vague test questions 📌 You may see a test question about long-term capital gain tax rates that doesn’t specify the investor’s income or the exact rate. In that case, assume a 15% long-term capital gains rate.
Reporting
Capital gains are reported on Form 1099-B (B stands for brokerage proceeds). Brokerage firms report customers’ capital gains and losses to the IRS each year.
| Result | Consequence |
|---|---|
| Net capital gain (more gains than losses) | Taxes are owed |
| Net capital loss | Can be used as a deduction |
Cost basis adjustments
Cost basis is used to calculate the capital gain or loss when a security is liquidated. In certain situations, the cost basis may be adjusted. In particular, we’ll focus on these two situations:
- Inherited securities
- Gifted securities
⚠️ Inherited vs. gifted securities
| Feature | Inherited securities | Gifted securities |
|---|---|---|
| Cost basis | Stepped up to the security’s value on the date of the original owner’s death | Recipient generally takes the original owner’s cost basis |
| Holding period | Automatically / always long-term, no matter how long the original owner held the investment | Does not reset — original holding period carries over |
| Tax outcome | Generally favorable; can significantly reduce tax liability | No special tax benefits |
Inherited securities
When securities are inherited, the tax rules are generally favorable. Two key benefits apply:
| # | Benefit |
|---|---|
| 1 | Cost basis is “stepped up” |
| 2 | The holding period is automatically long-term |
When an investor dies, their assets pass to beneficiaries. The beneficiary’s new cost basis is the security’s value on the date of the original owner’s death. The beneficiary’s holding period is treated as long-term, no matter how long the original owner held the investment.
Example:
An investor purchased 100 shares of ABC stock at $500 per share on January 10th, 2026. The investor died on June 10th, 2026 when ABC was at $1,000 per share. The investor’s daughter liquidated the inherited shares at $1,100 on July 1st, 2026.
Even though the shares were originally purchased at $500, the cost basis is “stepped up” to $1,000 on the original owner’s date of death. That step-up can reduce taxes significantly.
- With the step-up, the taxable gain is $100 per share ($1,100 sales proceeds − $1,000 cost basis).
- Without the step-up, the taxable gain would be $600 per share ($1,100 sales proceeds − $500 cost basis).
The gain is also treated as long-term, even though the shares were held for only about six months.
Assuming the inheritor is in the 32% tax bracket, here’s the difference in tax liability:
| Step | With inheritance tax rules | Without inheritance tax rules |
|---|---|---|
| Cost basis | $1,000 per share | $500 per share |
| Sales proceeds | $1,100 per share | $1,100 per share |
| Taxable gain per share | $100 | $600 |
| Overall gain | $100 gain x 100 shares = $10,000 | $600 gain x 100 shares = $60,000 |
| Tax liability | $10,000 gain x 15% (long term gain rate) = $1,500 | $60,000 gain x 32% (short term gain rate) = $19,200 |
These inheritance rules can significantly reduce tax liability. Instead of paying a 32% tax (the tax bracket that applies to short-term gains) on a $60,000 gain, the inheritor pays a 15% tax on a $10,000 gain. That’s a tax savings of $17,700.
Gifted securities
This is a simplification for exam purposes; the actual rules when filing taxes are more complex.
Gifted securities don’t receive the same tax benefits as inherited securities.
- The recipient generally takes the original owner’s cost basis.
- The holding period does not reset.
Using the same facts as the inheritance example (but treating the transfer as a gift):
An investor purchased 100 shares of ABC stock at $500 per share on January 10th, 2026. The investor gifted the shares to their daughter on June 10th, 2026, when ABC was $1,000 per share. The daughter liquidated the shares at $1,100 on July 1st, 2026.
In this case, the daughter keeps the original cost basis of $500 and the short-term holding period.
| Item | Value |
|---|---|
| Cost basis | $500 per share |
| Sales proceeds | $1,100 per share |
| Taxable gain per share | $600 |
| Overall gain | $600 gain x 100 shares = $60,000 |
| Tax liability | $60,000 gain x 32% (short term gain rate) = $19,200 |
Key points
Capital gain
- Securities sold for more than the basis
- Reported on tax form 1099-B
Capital loss
- Securities sold for less than the basis
- Reported on tax form 1099-B
Long-term capital gain
- Gain on security held more than 1 year
- Tax rate: 0%, 15%, or 20%
Short-term capital gain
- Gain on security held for 1 year or less
- Tax rate: up to 37% (income tax bracket)
Inherited securities
- Cost basis is stepped up to the value on the date of death
- The holding period is always long term
Gifted securities
- Security retains the original cost basis and holding period when gifted
Sources
Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.