Tax & EvaluationQuestion 96 of 110
An investor automatically reinvests $3,000 of taxable fund distributions over several years. The effect on cost basis is that basis:
a.Stays the same, because no new money was added from outside the account
b.Increases by the $3,000, because the distributions were already taxed
c.Decreases by the $3,000
d.Is irrelevant, since reinvested shares are always tax free when sold
Explanation
Reinvested distributions are taxed in the year received, so adding them to basis prevents the same dollars from being taxed again when the shares are sold. Failing to track reinvestments is a common cause of investors overstating their taxable gain. Basis decreases only for return of capital distributions.
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