Cost basis is the original purchase price of a stock plus any adjustments (commissions, reinvested dividends, stock splits).

It determines your capital gain/loss when selling: Capital Gain = Sale Price - Cost Basis.

Example: Buy 100 shares at $50 ($5,000 basis) + $10 commission = $5,010 basis.

Sell at $70 ($7,000) - $10 commission = $6,990.

Capital gain = $6,990 - $5,010 = $1,980 taxable.

Accurate basis calculation is crucial—understating basis means overpaying taxes, overstating basis triggers IRS penalties.

Track every adjustment: reinvested dividends increase basis (you already paid tax on dividends, so don't pay again on sale), stock splits adjust per-share basis (2-for-1 split: $50/share becomes $25/share basis), return of capital reduces basis.

Each reinvested dividend creates a new purchase lot with its own basis.

Process: (1) Record dividend amount and reinvestment date, (2) Calculate shares purchased (dividend ÷ stock price on reinvestment date), (3) Add dividend amount to total cost basis.

Example: Own 100 shares, $50 original basis/share = $5,000 total basis.

Receive $200 dividend, reinvest at $55/share = 3.636 shares.

New total: 103.636 shares, total basis $5,200 ($5,000 + $200).

New average basis: $5,200 ÷ 103.636 = $50.18/share.

Critical: Keep detailed records of each reinvestment—brokers often don't track pre-2011 basis correctly.

Use specific identification method to minimize taxes: sell highest-basis shares first to reduce capital gains.