In its most rudimentary form, basis is the cost of buying or taking ownership of an investment. Say you buy ten shares of stock for $1,000. That's your initial cost basis. You later sell all ten shares for $1,500. If the stock paid no dividends, you pay taxes only on the capital gain earned above that cost basis-in this case, $500. (This assumes this is not in a tax qualified retirement account.) That's simple enough. Unfortunately, it gets much more complicated than that.

First, did you remember to add to the basis any fees or commissions you paid for buying the stock? If you didn't, you either overpaid capital gains taxes or, if you suffered a loss, you've understated the loss and won't have as much to use to offset gains from other investments.

Were there any stock splits? That changes the basis of the individual shares, which becomes important if you sell only some of the shares. Basis may need to be adjusted when shares in one company are exchanged for shares in another company during a merger. Or in the case of incentive stock options, you may have one basis for regular tax and a different basis for purposes of the alternative minimum tax.

What's the basis if you inherited the ten shares of stock? It depends. It either is the fair market value of the shares on the day the person died (not the value of the stock the deceased originally paid for it), or its fair market value six months after the date of death if that's the valuation date the estate's executor chooses. If you receive stock as a gift, you receive it at the donor's basis as long as the current fair market value is equal to or higher than the donor's cost basis. If the current fair market value is less, you may end up using a different basis. You'll probably need a tax specialist to figure it out, but the important point is to be sure to get an accurate cost basis from the donor.

Mutual funds are also confusing. Say you buy $1,000 in shares of a stock mutual fund and hold the shares for two years. During that time, you receive $100 in dividends and capital gains, which you automatically reinvest. At the end of two years, you sell all the shares for $1,500. Is your taxable gain $500? No, it is $400. You had to pay taxes each year on that year's reinvested dividends and capital gains, so the adjusted basis by the time of sale is the original $1,000 plus the $100 in reinvested dividends and gains. This is a common basis error made by mutual fund investors. 

What about your home? As with the stock or mutual funds, start with the original amount you paid for it. You increase basis (and thus reduce any potential taxes) by adding on the cost of any improvements (not normal maintenance or repairs). You reduce basis for depreciation you claimed for a home office, energy credits claimed and numerous other adjustments. Rental property, including a vacation home, provides even more basis complications. Obviously, keeping accurate records, often for many years, are vital for determining-and proving-the adjusted basis.

Investment basis record keeping also has become more critical for estate tax planning. Currently, when you die your assets go to your heirs on a "stepped up" basis. That is, they inherit the assets, as noted earlier, at the fair market value of the assets on the day of death or the alternate valuation date.

However, under the new tax act, the estate tax is scheduled to be eliminated in 2010. At that point, a new carryover rule begins-that is, the deceased's basis in the property carries over to the heir in some cases. A certain amount of inherited assets will be exempt from taxes, but well-documented records will be necessary for the remaining assets, especially for assets the heirs hold on to such as a family business passed down multiple generations. Commentators warn of future disputes with the IRS, and attorneys who will charge extra fees because they have to spend extra time determining basis because of poor records.