No. of Recommendations: 6
ROC is not taxed
Well, sort of, but not really.
It is true that if a distribution is classified as Return of Capital, it’s not even reportable. But what does happen, is that it decreases your basis in the stock. So if you bought $1,000 worth of XYZ and received a RoC payment of $150, then your basis in XYZ is now $850. So if you sell XYZ for $1,500, you have a $650 gain, not $500, and of course you could be taxed on that extra $150 (or not, depending on way too many personal circumstances to go into here). But regardless of whether you end up paying tax on it or not, it’s definitely reportable.
So really what RoC does is convert what would be reportable income this year, into reportable income in the year you sell. Also, the income is converted from some sort of dividend into some sort of capital gain. Whether either of those is good or bad depends, again, on lots of circumstances.
One wrinkle—one might wonder what happens if you receive 7 $150 RoC payments from XYZ? That’s a total of $1,050 in RoC payments, and the basis can’t go below zero, so the last $50 (and any subsequent RoC payments) are classified as long-term capital gains, which *are* reportable and potentially taxable.
Of course that all applies just to taxable accounts, but it’s not true that any RoC advantage is “lost”, as the advantage (if there is one, it may turn out to be a disadvantage), isn’t nearly as big as “not taxed”.
Brian
