The Motley Fool Discussion Boards

Previous Page

Financial Planning / Tax Strategies

URL:  http://boards.fool.com/i-have-what-i-hope-is-an-interesting-question-23691864.aspx

Subject:  Re: Dividend, stock price & capital gain Date:  2/11/2006  5:18 PM
Author:  irasmilo Number:  83827 of 121095

I have what I hope is an interesting question based on the notion of buying a stock just for a special dividend payout. Looked through the FAQ and could not find an answer. If there is one, please point me to it.

Ameritrade recently paid a $6 special dividend and I would like to understand some tax implications for this. There is an explanation on Ameritrade's website under their FAQ (http://www.amtd.com/investors/faq.cfm -- click on FAQ #1), but it is not entirely clear to me.

Here's my attempt at an explanation. Could someone please tell me if I've got it right or not and, if not, what is really happening?

For initially buying below the selling price:
You buy at $16 and watch the stock rise to $25. On the ex-div date, the price drops to $19 because of the dividend. You later sell at $19.50. Suppose $2 of the $6 is determined to be dividend, as described by Ameritrade. You owe tax on that as either qualified or non-qualified dividend, depending on your holding period (rule in IRS Pub 550). The remaining $4 is taxed as capital gain at a rate determined by your holding period. In addition, you owe tax on $3.50 of capital gain for the sale above your buy price ($19.50 - $16 = $3.50), at a rate depending on your holding period (long or short term).

For initially buying above the selling price:
Same situation, but this time, the buy price is $22 instead of $16. The stock rises to $25. On the ex-div date, the price drops to $19 because of the dividend. You later sell at $19.50. You owe tax on the $2 determined to be dividend, as above. The remaining $4 is taken up as follows: $2.50 is used to recover to your "pro rata" share of Ameritrade at $22 ($19.50 - $22 + $2.50 of remaining $4 = zero). The remaining $1.50 of that $4 would be taxed as capital gain.

For buying too high:
Same situation, but this time, the buy price is $26 instead of $22 or $16. Stock falls to $25 and drops to $19 on the ex-div date. You sell at $19.50. Pay tax on the $2 dividend, as above. Have a capital loss of $2.50 ($19.50 - $26 + remaining $4 = neg $2.50) and no tax owed on that portion of the $6 special dividend.


Your calculations correct but far too complex and all of the intermediate price changes are irrelevant to the calculations. If you assume that $2 of the dividend is ordinary qualifying dividend and the remaining $4 is return of capital, all you do is subtract $4 from your cost basis when you calculate your gain or loss on sale.

For situation 1 -- you pay tax on the difference between 16-4=12 and $19.50 --> $7.50 capital gain.

For situation 2 -- you pay tax on the difference between 22-4=18 and $19.50 --> $1.50 capital gain.

For situation 3 -- you pay tax on the difference between 26-4=22 and $19.50 --> $2.50 capital loss.

Ira
Copyright 1996-2014 trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us