Don't forget the basis when computing your capital gains tax
By Kay Bell • Bankrate.com

Each of us has occasionally felt like Homer Simpson. Confronted by some silly mistake we made, we slap our forehead and mutter "D'oh!"

But when it comes to taxes, that "D'oh!" can cost dough. Sometimes the error means we have to pay more in taxes. Other times it delays the refund we're expecting from the Internal Revenue Service.

As we begin to prepare our tax returns in earnest, Bankrate.com will feature some of the most common tax return errors each week in "You Did What?!?"

Here's hoping this look at these errors will help you avoid the same missteps -- and help you get through filing with a fuller bank account and your good humor still intact!

Mistake #8: Not properly tracking your investment 'basis'
No one wants to pay the same tax twice, but that's what a lot of people do when they don't correctly figure the cost basis of the stocks or mutual funds they sold. Because calculating capital gains on stocks and funds involves several complicated steps, too many taxpayers focus on just determining the holding period -- long- or short-term -- or which specific shares they sold.

But the basis -- what you paid when you bought your investment -- is how you figure what portion of your sale is taxable. If you bought 100 shares for $10 each, your basis is $1,000. If you sold those 100 shares at $15 each, then your taxable gain would be $500 -- $1,500 sale price minus $1,000 original basis.

It gets complicated -- and potentially costly -- if your investment paid dividends or capital gains distributions that you reinvested in the stock or fund. Even though you reinvested these earnings, you paid tax on them the year they were reinvested. Don't give Uncle Sam tax money a second time when you sell!

Here's how this works. You bought your 100 shares for $1,000 in 1997, and that year had dividends of $100 that you reinvested. You paid tax on this $100 in 1997. In 1998, you got $200 in dividends, again reinvested and again paid on those earnings that year. In 1999 you sold the stock for $1,500. Now those reinvested dividends that you paid tax on in 1997-98 can help reduce your 1999 taxable gains.

Take the $1,000 original price and add the $100 reinvested in 1997 and the $200 in 1998, giving you an adjusted cost basis of $1,300. This is the amount you subtract from your sale price of $1,500, meaning you have taxable gain of $200 instead of $500.

To make sure you don't overpay the Internal Revenue Service tax due on investment earnings, be sure to hang on to all your stock and fund account statements. It may mean an extra folder in your filing cabinet, but it also could mean extra cash in your wallet at tax time.

-- Posted March 6, 2000