Cost basis is what you paid for an asset. Fair market value is what it’s worth right now. The difference between the two is what shows up on your tax bill, and getting that math wrong is one of the most expensive mistakes tech employees and investors make.
This guide breaks down what each term means, how cost basis works for RSUs and stock options specifically, and the most common cost basis mistakes that show up on Form 1099-B every April.
Quick definitions:
- Fair market value (FMV): the current, sellable price of an asset on any given day.
- Cost basis: what you paid for that asset, plus any commissions, fees, or qualifying improvements.
Cost basis reflects the past. Fair market value reflects today. The gap between them is your capital gain (or loss).
What’s the difference between fair market value and cost basis?
Cost basis is fixed. Fair market value moves. That’s the simplest way to remember which is which.
Your cost basis is the original price you paid. It doesn’t change just because you held the asset for ten years or because the stock tripled. Whether you sell on Monday or three years from Monday, the cost basis on those shares is the same number.
Fair market value, on the other hand, changes constantly. Public stock prices update every second the market is open. We’ve seen Nvidia rip in 2024 and First Republic Bank collapse in 2023. No one knows what FMV will be tomorrow, which is why cost basis is the anchor of every tax calculation.
One exception: cost basis can be adjusted in specific situations. Real estate cost basis grows with capital improvements per IRS rules. Stock cost basis can be adjusted when income from equity comp gets reported on both your W-2 and 1099-B (more on that below).
Why FMV minus cost basis equals your tax bill
The whole reason you need to know either term is taxes. The math is one line:
Fair market value at sale minus cost basis equals capital gain (or loss).
If you bought a stock for $10 and sold it for $15, your capital gain is $5 per share. That $5 is what you get taxed on, not the full $15 sale price.
How much tax depends on how long you held the asset:
- Held more than one year: long-term capital gains rates of 0%, 15%, or 20% depending on your taxable income tier.
- Held one year or less: short-term gain, taxed at your ordinary income rate, up to 37%.
That timing difference can be huge. A $50,000 gain taxed at the 37% short-term rate costs $18,500. The same gain taxed at 20% long-term costs $10,000. Holding the asset 366 days instead of 364 saves $8,500 on that example.
How is fair market value determined?
For publicly traded stock, fair market value is the closing price on whatever day you need it (the day of vest, the day of exercise, the day of sale). Brokerages report this automatically.
For private company stock, FMV is set by a 409A valuation, an independent appraisal a company pays for. Most private companies refresh their 409A at least once a year, sooner if a material event happens like a new round of funding, acquisition talks, or a big revenue change. The 409A price is what your stock options will list as their strike price for grants issued during that window.
If you have stock options at a private company that hasn’t gone public yet, the 409A is the FMV the IRS recognizes for tax purposes, even if you suspect the actual market would price it higher.
RSU cost basis: where employees get this wrong
Your RSU cost basis is the fair market value of the shares on the day they vest. Not zero. Not the strike price (RSUs don’t have one). Just the FMV on the vest date.
If 1,000 RSUs vest at a $50 share price, your cost basis on those 1,000 shares is $50,000. That $50,000 also gets reported as ordinary income on your W-2 the same year, which is why your employer typically sells some of the shares to cover withholding.
Where it goes wrong: when you eventually sell, your Form 1099-B from the brokerage often shows $0 cost basis (or blank) for those RSU shares. If you file your taxes from the 1099-B as-is, you’ll be taxed on the full sale price as if you’d received the shares for free, doubling up on income that already hit your W-2. Missing or mis-reported cost basis is the single most common RSU tax mistake.
If you want to estimate the tax gap on your next vest before tax time hits, our RSU tax withholding calculator runs the numbers based on your bracket.
Stock options cost basis (ISO, NSO, ESPP)
Cost basis works differently for each type of stock option:
- ISOs (Incentive Stock Options): cost basis is your strike price (what you paid to exercise). If you trigger AMT at exercise, your AMT cost basis is higher than your regular cost basis, and the two need to be tracked separately.
- NSOs (Nonqualified Stock Options): cost basis is your strike price plus the spread that was already taxed as ordinary income at exercise. The spread shows up on your W-2 the year you exercise.
- ESPPs (Employee Stock Purchase Plans): cost basis is the discounted purchase price plus any portion of the discount that was taxed as ordinary income (varies based on whether the disposition is qualifying or disqualifying).
The pattern: if any portion of the gain was already taxed as W-2 income, it gets added to your cost basis so you’re not taxed on it twice. Brokerages don’t always include the W-2 portion in the 1099-B basis, so the adjustment is on you.
Inherited and gifted stock: how cost basis steps up (or doesn’t)
Inherited stock gets a step-up in basis. Under IRC Section 1014, the heir’s cost basis becomes the FMV on the date of the original owner’s death. If your grandfather bought IBM at $5 a share in 1970 and died with shares worth $200, your inherited basis is $200, not $5. Sell shortly after and you owe tax on almost nothing.
Gifted stock is the opposite. The donor’s original cost basis carries over to you. If a parent gives you Apple stock they bought at $20 a share, your basis is $20, even if Apple is at $200 the day you receive it.
This is why estate planning around appreciated stock often favors holding until death and inheriting (step-up) over gifting during life (carryover).
Short-term vs long-term capital gains: timing the sale
The holding period that separates short-term from long-term is exactly one year and one day. The clock starts the day after you acquire the asset.
For RSUs, the clock starts the day after vest, not the day of grant. For stock options, it starts the day after exercise. For inherited stock, all gains are automatically considered long-term, regardless of how briefly you held the inherited shares.
Long-term rates (0/15/20%) are roughly half of short-term rates for most high earners. On any meaningful gain, holding past the one-year mark almost always wins. The exception: if the stock is dropping fast and you’d lose more than the tax savings by waiting, sell and take the short-term hit.
Cost basis mistakes that cost you tens of thousands
The same handful of errors show up every tax season:
- Filing 1099-B as-is when it shows missing or zero RSU cost basis. You’ll be taxed on income you already paid on. Cross-check the W-2 and 1099-B before filing every year.
- Forgetting to track AMT cost basis separately for ISOs. When you eventually sell, you owe regular tax on regular basis and AMT recovery on AMT basis. Two ledgers, not one.
- Treating gifted stock like inherited stock. Only inheritance gets a step-up. Gifts carry over the donor’s basis.
- Skipping capital improvements on real estate cost basis. A $40,000 kitchen renovation isn’t a deduction now, but it raises your cost basis and reduces the capital gain when you sell.
- Selling without thinking about the holding period. Selling on day 364 instead of day 366 can double your tax bill on that gain.
Failure to adjust incorrect cost basis can cost tens of thousands, sometimes hundreds of thousands, in tax that wasn’t actually owed.
Have a financial planner help you sort through fair market value vs cost basis
Knowing the difference between fair market value and cost basis is the first step toward smarter investing. Applying it to your specific situation, especially when stock options or RSUs are involved, is where most people lose money.
A financial planner who works with equity-comp clients can help you track cost basis correctly, plan around the holding period, and avoid the W-2/1099-B mismatch that catches most tech employees off guard.
To see if our firm would be a good fit, book a call here and we’ll walk through your equity comp, your tax situation, and what you should be tracking.
