To determine your basis in an asset for purposes of calculating capital gain or loss upon the sale or other disposition of the property, you need to understand two terms — initial basis and adjusted basis.
Often, your initial tax basis equals your cost — what you paid for the asset. For example, if you purchase one share of stock for $10,000, your initial basis in the stock will equal $10,000. However, your initial basis can differ from the cost if you did not purchase an asset, but rather received it as a gift, as an inheritance, or in a tax-free exchange.
It’s also important to understand the concept of adjusted basis. Your initial basis in an asset can increase or decrease over time. For example, if you buy a house for $100,000, your initial basis in the house will be $100,000. If you later improve your home by installing a $5,000 deck, your adjusted basis in the house may be $105,000. You should be aware of which items increase the basis of your asset, and which items decrease the basis of your asset.
To calculate a capital gain or loss, you need to know your adjusted basis in the asset. Essentially, capital gain or loss equals the amount you realize on the sale of your asset minus your adjusted basis in the asset.