Cost Basis

Basis (or cost basis), as used in United States tax law, is the original cost of property, adjusted for factors such as depreciation. When property is sold, the taxpayer pays/(saves) taxes on a capital gain/(loss) that equals the amount realized on the sale minus the sold property's basis.

The taxpayer deserves a tax-free "recovery" of the cost of acquiring a capital asset, because this cost is analogous to a "business expense" used to acquire income. This recovery is postponed to the year of disposition because of a further analogy to the accrual accounting principle of matching expenses to revenues: disposing of property will deprive the taxpayer of a valuable asset, leaving a "hole" that should be filled by some form of tax-free recovery. The size of this "hole" is set to equal that asset's original cost, but doing so is not logically necessary; rather, it arises from the administrative decision to levy income tax on asset appreciation at the moment of sale, rather than as it appreciates (in which case, basis would equal amount realized and there would be no tax at disposition—since appreciation taxes were levied by constant assessments).

IRS Publication 551 contains the IRS's definition of basis: "Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also use it to figure gain or loss on the sale or other disposition of property."