Help me understand stock sale cost basis

I’m have a bit of a hard time understanding cost basis, at least in one situation that I have now for my taxes.

I get that the cost basis is how much I’ve paid for a stock over time. So if I buy 100 shares of stock for $1000 total, my cost basis is the $1000. Easy enough. If I buy the same 100 shares of stock and reinvest my dividends for 10 years the cost basis is the $1000 plus all the dividends I’ve gotten in the last 10 years.

Now for the part I can’t wrap my head around, and it’s what I have to deal with for my taxes this year. I get 100 shares of stock in 2000, I reinvest the dividends. In 2005 I sell 25 shares. At the time I seem to have done my cost basis for those I sold. Last year I sold another 25 and I haven’t a clue as to how to do my cost basis.

My father, the one who gave me the stock, tried to help me out, but I couldn’t make heads or tails of it. Something about using the average price of the stock as it was bought,which I kind of get, but then he told me that in my case, selling for a second time, I’m to average the cost of only my dividends between 2005 and 2013. But that doesn’t make total sense to me since I’m selling some of my original stock so shouldn’t I also, some how, be using the price of when it was originally bought as well?

I know I’m missing one key thought process, I just can’t see where.

You should have already paid tax on the dividends so that becomes part of your basis cost. If you bought 1000 shares at $10.00 per share and earned $1000 in dividends ending up with 1100 shares, your basis cost is the original $10,000 plus the $1,000 in dividends, or $11,000.

Traditionally, there have been different options available to the tax payer to calculate cost basis:

  1. Average Cost Basis, which is probably what your father is referring to.
  2. FIFO, which actually makes logical sense.
  3. Specific lots - this applies if you specify which lots the shares are coming from when you make trades. Most people don’t do this.

For FIFO, you would simply consider each bunch of additional shares to be acquired at the basis that applied when they were bought with your dividends. When you sell, the oldest shares are sold first, and their cost basis applies. So in your scenario, the two sales of 25 are at your original basis, and you still have 50 at the original basis, and more shares acquired later on at other bases, which will come into play once you’ve sold the original 100.

The averaging will often give you less gain, and whether it’s worth doing or not is up to you.

This PITA is one reason why I never reinvest dividends - the other is that accumulating money from dividends forces me to think about what the money OUGHT to be invested in, rather than just picking up more shares of something by neglect.

Note that I said “traditionally”. In the last few years, brokerages have been required to report your cost basis and gains to you from sales to the IRS. You can just use the brokerage figures, which probably best for the average person.

For Average Cost Basis (A) simply take the full cost basis for all the shares you own (B), divide by the number of shares then multiply by the number of shares sold.
(A) = (B) * number_of_shares_sold/number_of_shares_owned

After the sale the new cost basis is (C ) = (B) - (A)

I don’t think that the brokerage has given me all the numbers I would need. I’ve owned them since around 1997. I wish I had the paperwork in front of me, but I think I was given 100 shares. In 2005 I sold 50-60 to buy a house. Last year I sold 60 again, so I’m past my original 100 shares.

That’s why I’m having such a hard time figuring it out. I’m also trying to see how I will handle it the next time I sell some stock.

What type of account? If it is a ROTH then fuggedaboudit.

You buy some stocks 100 @ $10 - you have stocks that cost $10.
You get dividends - $240 to buy stocks at $12 - you buy 20 stocks.

If you’re averaging -
You’ve bought 120 stocks and spent $1240, so each stock is costed 1240/120 = $10.33
You sell 30, you have 90 stock costed $10.33 each, or 1240- (30x10.333)=$930
(all the stock you kept “cost” the same as the stock you sold, the total amount is what you’ve spent so far.)

You get another $140 in dividends and stock costs $14 each, so you buy 10 stock.
You have 100 stock (90+10) costed at $1070 (i.e. $930+$140) which is costed at $10.70 each.

Basically, each time you sell you figure how much of the original pie you have sold.
In the long run, your cost basis averaging still means when you have sold all your stock, the total “cost” of what you sold equals the same as what it cost you in total to acquire all that stock.

I think I might have it now, I think I see what I was missing. When I sell I average the value of the stock, what I paid for them originally really means nothing. I keep that average for the next time I go to sell and then average the value yet again. I was missing the value of the original stock is meaningless in this situation.

This is worth repeating – these days, the broker has to do this work for you (there are some exceptions for old investments, but all of my brokers did it anyway). Check the forms you got from them reporting the sales, and it’ll probably be there.

Exactly. Every time you do a sale ALL your stock “cost” the average price you calculated. Take that number forward.

Next time you sell stock, you re-average; that average price for the existing stock, plus the quantity and cost of any further stock you bought before that next sale.

Simple test - if you sell ALL your stock, the cost basis totals -all prior sales plus current stock - should add up be the total dollars that went to buy it all.