Figuring cost basis: If it's reinvested, it counts

— -- Q: When figuring my cost basis on stocks, do I factor in reinvested short-term gains, reinvested long-term gains or reinvested dividends?

A: Wow. Another question about the cost basis on stocks. Not sure why the topic is so popular all of a sudden.

Perhaps the confusion over cost basis stems from misunderstanding what it is. Your cost basis, or just plain basis, in a stock is what you've paid for the investment, including commissions and any reinvested dividends.

The basis is important because it's used to calculate what you owe in capital gains taxes, which is probably why so many investors are so interested. You don't want to pay more taxes than you owe.

Most people understand the cost portion of the basis. Let's assume we're talking about a taxable account here and use the example below.

Let's say you paid $1,500 for a stock, including a $50 commission, and you sell it for $2,000, including another $50 commission. In that case, your cost basis is $1,500 plus the $50 commission you paid on the sale. That means you owe capital gains taxes on the $400 difference between your basis and the $1,950 net proceeds of the sale.

But what if you received dividends of $500 during the time you owned the stock and reinvested that money in more stock? Then your cost basis is dramatically different. Your basis is the $1,500 you paid for the stock plus the $500 in dividends you reinvested, or $2000.

Now, when you talk about reinvested short-term and long-term gains, you're talking about mutual fund distributions.

When a mutual fund sells a stock in its portfolio for a gain, it must pass that gain along to the fund's shareholders; that's you. You may reinvest that gain to buy additional shares of the fund. And if you do, those gains, short- or long-term, are simply added to your cost basis in the fund.

If you have many stocks and funds to track, I urge you to try using personal financial software like Intuit's Quicken. The software knows all the rules and will help you track your basis. Or at the least, keep careful track on your own spreadsheet. When you go to sell your stocks or funds, you'll be glad you did.