The cost basis of shares acquired through a dividend reinvestment plan equals the dividend amount used to buy them, plus any fees charged on that purchase. Every reinvestment is a separate lot with its own price, date, and holding period, so a few years of quarterly dividends can leave you with dozens of small lots to track. Get the basis wrong when you sell and you can end up paying capital gains tax on money you already paid income tax on.
How Each Reinvestment Sets Its Own Basis
The IRS treats a reinvested dividend two ways at once. It is taxable dividend income in the year it is paid, reported on Form 1099-DIV in Box 1a (with the qualified portion in Box 1b).1Internal Revenue Service. Instructions for Form 1099-DIV That same dividend amount also becomes your cost basis in the new shares it buys, which is what keeps you from being taxed on those dollars a second time when you eventually sell.2Internal Revenue Service. FAQ on Calculating Basis for Dividend Reinvestment Plan Stock
If your broker or transfer agent charged a fee on the reinvestment, add it to the basis of that lot. A $150 dividend reinvested with a $3 service fee produces $150 of dividend income and a cost basis of $153 in the new shares. The service charge itself is also reportable dividend income, and you may be able to deduct it as an investment expense.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
Discounted DRIP Shares Change the Math
Some company-sponsored plans let you buy shares below market price. Your basis in those shares is not what you paid. It is the full fair market value on the dividend payment date, and the discount counts as additional dividend income.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
Say a $200 dividend buys shares through a plan offering a 5% discount. You receive shares worth $210.53 at fair market value. You report $210.53 as dividend income, and your basis in those shares is $210.53. The extra $10.53 is taxable now but also lifts your basis, so it will not be taxed again as a capital gain later. The same rule applies to optional cash purchases made at a discount: the spread between what you invest and the fair market value is dividend income.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
A Worked Example
Suppose you reinvest four quarterly dividends in a single year:
- Q1: $75.00 dividend buys 1.5 shares at $50.00
- Q2: $80.00 dividend buys 1.4815 shares at $54.00
- Q3: $82.50 dividend buys 1.5566 shares at $53.00
- Q4: $85.00 dividend buys 1.4655 shares at $58.00
You now hold 6.0036 new shares across four lots with cost bases of $75.00, $80.00, $82.50, and $85.00. Total basis: $322.50, exactly the dividend income you reported that year.
Two years later the stock trades at $65.00 and you sell three shares. Your gain depends entirely on which lot each share came from. A Q1 share at a $50.00 basis produces a $15.00 gain. A Q4 share at a $58.00 basis produces $7.00. Which lots you sell matters, and you have some say in the choice.
Choosing a Cost Basis Method When You Sell
FIFO
FIFO is the default. If you do not tell your broker otherwise, the IRS assumes you sold the oldest shares first.2Internal Revenue Service. FAQ on Calculating Basis for Dividend Reinvestment Plan Stock Older lots usually have a lower basis, so FIFO tends to produce larger reported gains, but those gains are more likely to qualify for long-term rates.
Specific Identification
Specific identification gives you control over the tax outcome. You choose which lots to sell: the highest-basis lots to minimize gain, or lots held more than a year to lock in long-term treatment. You have to identify the shares to your broker before or at the time of sale and keep records of the choice.4Internal Revenue Service. Publication 551 – Basis of Assets
Average Cost
Average cost divides your total basis by your total shares, giving every share the same per-share basis. The IRS permits this method for DRIP shares left on deposit with a custodian or agent.5Internal Revenue Service. Mutual Funds (Costs, Distributions, etc.) 1 In the example above, the average basis is $322.50 divided by 6.0036 shares, or about $53.72 per share. It is easier, but you lose the ability to pick high-cost lots to shrink your gain, and once you elect it for a given security you generally have to stay with it.
Holding Periods Run Lot by Lot
Each lot starts its own holding period on the day after the reinvestment date. More than a year gets long-term capital gains rates; a year or less is ordinary income.6Internal Revenue Service. Topic no. 409, Capital gains and losses A DRIP that has been running for years holds a mix of long- and short-term lots at all times, because the most recent quarterly purchase is always short-term. If you sell without specifying lots, watch what the default gives you: harvesting losses by specifically identifying recent lots can accidentally trigger short-term treatment.
Watch Out for Wash Sales
The wash sale rule disallows a loss if you buy the same stock within 30 days before or after selling it at a loss.7Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss from wash sales of stock or securities An automatic DRIP reinvestment counts as a purchase. Sell shares at a loss, let a dividend pay two weeks later, and the automatic reinvestment can wipe out part or all of your loss deduction for the year.
The loss is not gone forever. The disallowed amount is added to the basis of the replacement shares acquired through the DRIP, and you recover it when you sell those, assuming no further wash sale.7Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss from wash sales of stock or securities The practical fix is to turn off the DRIP before selling at a loss and leave it off for at least 31 days.
Return of Capital Reduces Your Basis
Not every reinvested distribution is a dividend. Return of capital, also called a nondividend distribution, appears in Box 3 of Form 1099-DIV. It is not taxable income. Instead, it reduces the basis of the shares you already hold.8Internal Revenue Service. Mutual Funds (Costs, Distributions, etc.) A lower basis means a bigger gain when you sell, and if your basis reaches zero, further distributions are taxed as capital gains. REITs and some energy partnerships often distribute return of capital, so DRIP holders in those sectors should check Box 3 every year and update their records.
Covered Versus Non-Covered Lots
Brokers must report the basis of covered securities on Form 1099-B when you sell. For individual stocks, shares acquired after January 1, 2011 are generally covered. Shares acquired before that date are non-covered, and the broker may not report basis at all.9Internal Revenue Service. 2011 Instructions for Form 1099-B
A DRIP that predates 2011 contains both kinds of lots. When you sell a mix, Form 1099-B separates them and you supply the basis for non-covered shares yourself on Form 8949 and Schedule D.10Internal Revenue Service. Instructions for Schedule D (Form 1040)
This is why the reinvestment statements matter. You need the date, share count, per-share price, and any fees for every reinvestment back to the day you started. If the records are gone, reconstruct them from old 1099-DIV forms, historical price data, or transfer agent records.2Internal Revenue Service. FAQ on Calculating Basis for Dividend Reinvestment Plan Stock Rebuilding a decade of quarterly lots is tedious, but it beats being taxed twice on the same income.
DRIPs Inside Retirement Accounts
Everything above assumes a taxable brokerage account. Inside a traditional or Roth IRA there is no per-lot basis to track: traditional IRA withdrawals are taxed as ordinary income regardless of what the shares cost, and qualified Roth distributions come out tax-free. The reinvestment records that matter so much in a taxable account are not needed here.