Stock Dividends increase cost basis?

[Dick Balaska]

Hi ho,

One thing i don't get, is why Interest Earned and Dividends increase my cost
basis. -- (This is just on the pretty graphs and don't really affect
transactions.)

So, if i buy 100 shares of XXX.O for $1000, my cost basis is $1000.
Next month i get a dividend of $10 and my cost basis goes up to $1010.
But, but, but, those shares didn't cost me $1010. My cost basis is still $1000,
or if anything, my cost basis is $990 (because i made that $10 back).

I've been stumped by this for years.
Can anyone esplain the logic behind this?

Danke

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[Fred Smith]

Certainly.

Your cost basis is the amount you've paid tax on. When you initially buy a stock
for $1000, you pay with after-tax dollars. To ensure you don't get taxed twice,
you are deduct your cost base from the proceeds of a sale in determining your
taxable income.

When you reinvest a $10 dividend, you pay tax on the dividend, even though you
don't get any cash. Your cost base increases, because you've now paid tax on
$1010 of your investment. Without this adjustment, you would be taxed twice on
the dividend -- once when it's reinvested, and again when you sell.

 

[MyVeryOwnSelf]

One thing i don't get, is why Interest Earned and Dividends increase

my cost basis. -- (This is just on the pretty graphs and don't really
affect transactions.)

So, if i buy 100 shares of XXX.O for $1000, my cost basis is $1000.
Next month i get a dividend of $10 and my cost basis goes up to $1010.
But, but, but, those shares didn't cost me $1010. My cost basis is
still $1000, or if anything, my cost basis is $990 (because i made
that $10 back).

I've been stumped by this for years.
Can anyone esplain the logic behind this?

Maybe you're thinking about dividend reinvestment. Typically, mutual funds
allow you to choose dividend reinvestment. Some common stocks offer it too.

Each time you reinvest dividends, there are actually two transactions
happening:

1. You receive a dividend of (say) $10. The dividend is subject to income
tax (unless it's, like, a muni bond mutual fund).

2. You invest the $10 in the same security and get extra shares. You now
have 100-plus-extra shares. The 100 shares still have $1000 basis. The
extra shares have $10 basis.

 

[Andrew]

Maybe you're thinking about dividend reinvestment. Typically, mutual
funds allow you to choose dividend reinvestment. Some common stocks
offer it too.

Each time you reinvest dividends, there are actually two transactions
happening:

1. You receive a dividend of (say) $10. The dividend is subject to
income tax (unless it's, like, a muni bond mutual fund).

2. You invest the $10 in the same security and get extra shares. You
now have 100-plus-extra shares. The 100 shares still have $1000
basis. The extra shares have $10 basis.

Wait a second - The OP never said anything about reinvestments of the
dividend. He simply said he received a dividend. In his scenario, there is
no cost basis increase. He is taxed of course on the dividend, but the
original number of shares stays the same with the original cost basis.

 

[DP]

As Andrew noted, you didn't mention anything about dividend reinvestment to
buy new shares. But that's what it sounds like you're talking about. Are
you?

 

[Dick Balaska]

No dividend reinvestment. The dividends go to the cash part of the account.
This particular account is an IRA, no taxes yet, but i sort of see the logic on
the dividend taxing thing applying to the cost basis.

I guess my only problem is that in the purdy graphs[1], i can't see how much
i've actually invested.

[1] I can't believe after 10 years that the graph engine still suffers that
single-threaded-broken drawing algorithm at it's heart.

dik

 

[Andrew]

No dividend reinvestment. The dividends go to the cash part of the
account. This particular account is an IRA, no taxes yet, but i sort
of see the logic on the dividend taxing thing applying to the cost
basis.

I guess my only problem is that in the purdy graphs[1], i can't see
how much i've actually invested.

[1] I can't believe after 10 years that the graph engine still
suffers that single-threaded-broken drawing algorithm at it's heart.

dik

Dick - You have several different items playing here. First, then if you
are simply parking the dividends in a cash account, then the cost basis will
not increase as I previously mentioned, so you should never have been seeing
any increase or worrying about it in the first place.

But NOW you mention we're dealing with an IRA account; all sorts of
different rules. Assuming you're talking about a regular IRA (vs. a Roth),
then any ultimate withdrawals from this stock account (original value plus
any reinvested dividends) are taxed as ordinary income anyway, and the whole
subject of cost basis gets thrown out the window anyway. Cost basis is
generally $0. You took your deduction from your earned income earlier when
you funded the IRA to purchase the original stock, right? So none of the
money that you will be ultimately withdrawing has ever had taxes taken, thus
no cost basis to worry about. (There's the good ness of the Roth IRA, but
that's a whole different subject).

btw, I'm not a tax pro, so all information provided is worth what you paid
me for.