J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

32.2 Reinvestment Plans

A mutual fund will allow you to reinvest dividends and capital gain distributions from the fund in new fund shares instead of receiving cash. You report reinvested distributions as if you received them in cash. Form 1099-DIV sent to you by a fund reports the gross amount of taxable distributions that you must report on your return (32.3).

Keep track of reinvested distributions.

If you reinvest your mutual-fund distributions instead of taking them in cash, you will need a record of the distributions and of the shares purchased with the reinvestment; your fund can likely provide you with a history of your reinvestments. The reinvested distributions are considered your cost basis for the acquired shares. You need a record of reinvestments to figure your cost when you sell your shares; see below (32.8) for calculating gain on the sale of mutual-fund shares.

Reinvested distribution can trigger wash sale.

If you redeem fund shares at a loss within 30 days before or after a dividend distribution is reinvested into your account, a “wash sale” results, and the portion of the loss allocable to the reinvestment is not deductible (30.6). The allocable loss is disallowed even though the wash sale was inadvertently caused by the reinvestment. The disallowed loss is actually deferred, as it is added to the cost basis of the replacement shares and will affect the computation of gain or loss on a later sale.