At this time of the year, you’re probably getting records together so you can file your tax returns for 2011. If you sold any investments held in a taxable account, you’ll report a taxable gain or loss on those sales.
At first glance, the process seems straightforward. If you bought stock for $10,000 and sold it for $12,000, for example, you have a $2,000 taxable gain. If you sold that stock for $9,000, you have a $1,000 taxable loss.
However, that calculation does not always provide the right answer. If you held that stock for any length of time, you might have received dividends. Many investors choose to reinvest dividends; if that’s what you did, your basis should be increased to reflect the reinvestments.
Say that $10,000 worth of stock generated $1,200 worth of dividends over the years. That would make your “cost basis” in the stock $11,200, not $10,000. Continuing the example, you’d have a smaller gain (only $800) on a sale for $12,000 or larger capital loss ($2,200) on a sale for $9,000.
With mutual funds, you should include reinvested capital gains distributions as well as reinvested dividends. You’ve already paid tax on those dividends and distributions, in a taxable account. Unless you adjust your cost basis to reflect your reinvestments, you’ll wind up paying double tax on the same investment income.
