Complications in calculating cost basis for DRIP investments ( 'Dividend Reinvestment Plan - DRIP')

Karin Price Mueller/The Star-Ledger  writes: Question:  This idea of "cost basis" for the sale of stocks seems more complicated than it should be. I have had certain DRIPs for 15 years or more. I need to calculate the cost basis when I sell a stock, but I don’t have a computer or the software to make the calculations. I’m afraid to have a professional do the calculations because I fear the cost will eat up what meager profits I make. Can’t I just add up the dividends that I already paid tax on, and then deduct that amount from the profit I made after selling the stock?

— Gary

Answer:  You’re correct that many tax calculations are complex, but it is what it is.

For the uninitiated, DRIP stands for Dividend Reinvestment Plan, in which the dividends paid out are used to automatically purchase more shares of the stock. You have to pay taxes on the dividends whether they’re reinvested or not.

As much as just adding up the dividends seems good enough, it is far from accurate, said Douglas Duerr, a certified financial planner and certified public accountant with U.S. Wealth Management in Montville.

"When you receive dividends through a DRIP, you then buy the applicable amount of shares based on the total amount of dividends and the stock price that day," Duerr said. "These amounts need to be added to your cost basis to accurately reflect the true cost value of the stock owned."

Duerr said you also need to pay attention to whether or not the stock split at all over the time period you owned it. If it did, it would impact the total number of shares owned and the value.

Another key question is whether you’re selling all your shares at once, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Berkeley Heights.

If you are, the calculation is more simple.

"He would add up all the dollars invested including the dividends and compare it to the selling price," he said. " The difference would be his gain or loss."

If you’re only selling some of the shares, Maye said, you can’t use an average cost basis to calculate a gain or loss.

Maye said the IRS only allows two methods of accounting on the sale of individual stocks.
The first method assumes that the first shares acquired are the first shares sold, better known as FIFO, or "first-in, first-out."

The second approved method is to use specific identification of exactly which shares are sold.

"Using the specific identification method allows the taxpayer to better manage the gains or losses from the sale of individual stocks," he said.

Maye said the IRS assumes you are using FIFO unless you and the broker take the necessary steps to specify which shares are being sold.

"The burden is really on the reader to maintain the necessary records to calculate gains or losses when he sells an individual stock," Maye said. "Even if he were to hire someone to figure out cost basis, the first thing they will ask for are his records."

Finally, Maye suggests, if you reader want to avoid the hassle of calculating the gains and losses, you could donate the shares to charity, and you’d avoid capital gains altogether.

"However, he would not be able to also claim it as an itemized deduction," Maye said.

Duerr recommends you consider going to your local library to use the public computers to make the necessary calculations.