Stock prices might split or merge from time to time, but splits can't change your actual purchase price. It does affect the cost basis of the stock, however, which is used when calculating your taxable capital gains.
Your purchase price is the actual price you paid for the stock. This may or may not be your cost basis. If you paid a broker commission when purchasing the stock, this also factors into the cost basis. As an example, if you purchased 100 shares of stock ABC for $25, your total purchase price is $2,500. If you paid a $100 broker commission, this is added to the purchase price for a total cost of $2,600. This total cost is then divided by the 100 shares to calculate the cost basis of $26 per share. This effective purchase price changes if the stock splits.
Cost basis describes your initial per-share expense when calculating capital gains. After all, you're only taxed on your profits. In the previous example, if you sold 50 shares of stock ABC for a total of $2,000 minus commissions, multiplying 50 times the $26 cost basis calculates the sale's total cost basis of $1,300. Subtracting this figure from $2,000 calculates $700 in capital gains.
Stocks split for a variety of reasons, but commonly it's to give the illusion of a bargain to encourage buying. As an example, stock ABC might skyrocket to $150 per share. The company might fear that people will view this stock as over-valued, so it issues a four-to-one stock split. This effectively produces four shares for every one share originally issued, including the ones you own. It also divides the price by four. The new $37.50 price seems like a bargain, even if the company itself has the same value.
Cost Basis After Stock Splits
Just as a stock split affects the current stock price, it also affects your original cost basis. Multiplying the split ratio, such as 4:1, by the number of shares you owned before the split calculates the number of shares you own after the split. In the example, multiplying 100 times by 4 gives you a total ownership of 400 shares. Dividing your total original cost of $2,600 by this figure calculates your new cost basis of $6.50 per share. A shortcut to this calculation is taking your original per-share cost basis and dividing it by the split ratio. In the example, $26 divided by 4 produces the same $6.50 per-share cost basis.
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