Do Reinvested Dividends Increase Your Cost Basis?

by Vicki A. Benge

Investors who use a dividend reinvestment plan through a public company, a brokerage firm or a transfer agent must maintain detailed records to meet Internal Revenue Service regulations concerning the reporting and payment of taxes on the income. In addition, the data will be needed to figure the cost basis of the shares of stock if and when the shares are sold as reinvested dividends affect the cost basis in the stock.

Fair Market Value

For the 2011 tax year, investors who utilize a dividend reinvestment plan to purchase additional shares of stock need to remain aware of the sales prices. According to IRS Publication 550, Investment Income and Expenses, if the shares are offered to you at a discount below current fair market value, the basis still equals the fair market value as of the dividend payment date. The discount below the full fair market value must be reported to the IRS on federal tax returns as income. For future purposes, record the fair market value as your cost basis in the shares.

Fees and Cost Basis

If brokerage fees or charges from transfer agents to move shares purchased with reinvested dividends are subtracted from your dividend income as part of the actual reinvestment purchase, these amounts must be reported on federal tax returns as income for taxation purposes. However, according to IRS regulations, these fees and any applicable transfer taxes add to your cost basis for the shares. Be sure to keep records for future reference.

Basis for Different Prices

Because stock prices often change from trading day to trading day, the IRS recommends maintaining records of the varying purchase prices for shares of stock from the same company until such time as you no longer own the shares. When selling shares of stock, the cost basis will need to be figured for both shares purchased with cash and for shares purchased with reinvested dividends.

First-In First-Out

In the event that distinct purchases cannot be accurately separated by price, the IRS uses what the agency calls a "first-in first-out" method to figure cost basis. Suppose, you purchase 100 shares of a stock at $25 each, reinvest dividends to purchase 3.89 shares, then purchase 100 additional shares over a period of two years through both multiple cash purchases and reinvested dividends. The record-keeping could get quite confusing as to what shares cost what. The IRS states that if you sell shares of the stock, the shares purchased first are considered the first sold and the basis of the original shares is what you would report for federal tax purposes. This method of first-in first-out should then be used on down the line to figure cost basis until you relinquish your holdings in a particular stock, regardless of whether you paid cash or reinvested dividends.

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