Basis: Definition and Examples in Finance

Basis is a finance term that most commonly refers to the cost or tax basis of an investment—the total amount paid for a security or asset (including commissions and fees). It is also used in commodities and futures markets to describe the difference between the spot (cash) price of an asset and the price of its corresponding futures contract. Basis is a key figure for calculating capital gains or losses and for evaluating hedging and delivery decisions in commodity trading.

Key takeaways

• As a cost basis (tax basis), basis equals the purchase price plus commissions and other acquisition costs; it determines capital gains or losses on disposition.
• In futures markets, basis is the difference between the cash (spot) price and the futures price of a commodity; it changes over time and affects hedging and arbitrage decisions.
• For IRAs, nondeductible (after‑tax) contributions create basis that can reduce taxable distributions; filing IRS Form 8606 is required to track these amounts.

Basis as cost (cost basis / tax basis)

A security’s basis is the amount paid to acquire it, including transaction fees. When you sell the security, capital gain or loss is calculated as:
sale proceeds − basis = gain (or loss).

Example:
* You buy 1,000 shares at $7.00 per share. Basis = 1,000 × $7.00 = $7,000.
If you later sell those shares, your gain or loss is computed using that $7,000 basis.

Basis in the futures market

In commodities and futures trading, basis = cash (spot) price − futures price. The basis:
* Varies over time as futures prices and spot prices move.
* May be affected by quality differences, storage and transportation costs, and delivery locations.
* Narrows as the futures contract approaches expiration (spot and futures prices converge).
Traders and hedgers monitor basis to decide whether to deliver or take delivery, to evaluate hedge effectiveness, and to search for arbitrage opportunities.

Basis and IRAs

Nondeductible (after‑tax) contributions to traditional IRAs create basis inside the account. Earnings on those amounts remain tax‑deferred, but distributions that represent basis are not taxed. To preserve the tax‑free treatment of taxable‑basis amounts, taxpayers must file IRS Form 8606 for any year they:
* Make nondeductible contributions to a traditional IRA, or
* Take distributions from traditional, SEP, or SIMPLE IRAs that include nondeductible amounts.

Example:
* IRA value = $100,000; nondeductible contributions (basis) = $20,000 → basis = 20% of the IRA.
If you withdraw $40,000, 20% (or $8,000) is treated as basis and is not taxed.

Failing to file Form 8606 can lead to double taxation of nondeductible amounts and potential IRS penalties.

Practical implications

• Maintain accurate records of purchase prices, commissions, and any adjustments (e.g., stock splits, return of capital) to calculate correct basis.
• For taxable accounts, basis determines the amount subject to tax when assets are sold.
• For commodity traders, tracking basis is essential for optimizing hedges and delivery decisions.
• For IRA owners who make nondeductible contributions, timely filing of Form 8606 is necessary to avoid unintended tax consequences.

Bottom line

Basis is a fundamental concept in both tax accounting and commodity/futures markets: as cost basis, it defines the taxable portion of investment gains or losses; as futures basis, it reflects the relationship between spot and futures prices and influences hedging and arbitrage strategies. Keep clear records and follow IRS rules (including Form 8606 where applicable) to ensure correct tax treatment.