Can someone please explain me the concept of Cost Basis? In Curriculum it is defined as “the amount that was paid to acquire an asset. It serves as the foundation for calculating a capital gain, which equals the selling price less the cost basis”. It also says that, when selling price is same as the original price which is the cost Basis, B = 1. It seems to me that when B is 1, investment return is zero (as there is no capital gains). But this is certainly not true (as shown in example 3 of Reading 9). We can have capital gains even when B is 1.
Looking a stock, capital gains (loss) is essentially the change in price between purchase and sale. So if you bought and sold at exactly the same price there would be no cap gains. However, there is usually an income component (e.g. dividends) to the return. So if you bought and sold at same price, but a dividend was collected the return would be positive. I don’t have the curriculum, so can’t offer more help than that.
If cost basis is 1, exactly all gains are taxed while entire purchasing price is tax deductible. If cost basis is < 1, Tax Authority does not recognize part of cost as tax deductible, thus not only gains are taxed bur also part of purchasing cost. If cost basis is > 1, part of cost are tax deductible what means, tax payer would use deductibles and pay less taxes.
Lower Cost basis - more taxes will be paid. Cost basis is determined by Tax Authority and tax legislative.
In the context of reading 9, cost basis reflects unrealized capital gains that have already occured. They have not been taxed yet, but they will be when position is liquidated. The FVIF ( future value interest factor) formulas need to factor in those future taxes on historical g/l, that is why the historical cost basis B is a component of these formulas.