Some corporations allow investors to choose to use their dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan, you must report the fair market value on the dividend payment date of the dividends that are reinvested as income on your tax return. You do not actually show that the dividends were reinvested on your return. Keep records of the dollar amount of the reinvested dividends, the number of additional shares purchased, and the purchase dates. You will need this information to establish your basis when you sell the shares.

Report the dividends that were reinvested with your other dividends, if any, on Form 1040 (PDF) or Form 1040A (PDF). If your total income from ordinary dividends exceeds a dollar amount set by law, you also must file either Form 1040, Schedule B (PDF) or Form 1040A, Schedule 1 (PDF).

For more information on this and other types of dividend reinvestment plans, refer to Ordinary Dividends in Chapter 1 of Publication 550, Investment Income and Expenses and Tax Topic 404, Dividends.

The basis of the stock you sold is the cost of the shares plus any adjustments, such as sales commissions. If you have not kept detailed records of your dividend reinvestments, you may be able to reconstruct those records with the help of public records from sources such as the media, your broker, or the company that issued the dividends.

If you cannot specifically identify which shares were sold, you must use the first-in first-out rule. This means that you deem that you sold the oldest shares first, then the next oldest, until you have accounted for the number of shares in the sale. In order to establish the basis of these shares, you need to have kept adequate documentation of all your purchases, including those that were made through the dividend reinvestment plan. You may not use an average cost basis. Only mutual fund shares may have an average cost basis.

Refer to Publication 550, Investment Income and Expenses, and Publication 551, Basis of Assets.