Cost basis is a key component in determining capital gains or losses when you sell a security. It is the original purchase price of the security plus additional costs such as paid commissions or fees. It is an important consideration when electing either a long-term or short-term capital gains tax rate.

Cost basis plays a large role in taxation strategies because it plays a key role in the determination of capital gains or losses. When a security is sold, the sale proceeds are subtracted from the cost basis to determine the gain or loss on the transaction.

For example, if an investor purchased 100 shares of XYZ stock at $15 per share for a total of $1,500 plus commission of $25, the cost basis of the XYZ stock would be $1,525. If the stock is sold for $2,000 plus $25 in commission, the profit or capital gain on the transaction is $475. This gain is subjected to either long-term or short-term capital gains tax, depending on the length of time the investor held the shares.

The cost basis of the stock is just one component of its capital gains or losses. Other components include amortization, which is an accounting cost to recover the value of an asset investment, depreciation, which reduces the cost basis as it represents the normal wear and tear that all assets experience, and accumulated gains, which represent market gains in excess of the cost basis.

In addition to being used to determine profits or losses when a security is sold, the cost basis is also used to determine taxes on dividend payments made by the issuer of the security. Typically, all dividend payments are subject to the same tax rate regardless of the security's cost basis.

Cost basis is an important factor for investors to consider when developing a tax strategy when their holdings are sold or when they plan to receive dividends from their investments. In addition to assisting in the calculation of taxes, understanding the cost basis of an investment can give investors a better sense of their return on investment.