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Re: Investment Addon



On Tue, 9 Aug 2011, Chris Travers wrote:

On Tue, Aug 9, 2011 at 9:33 PM, Luke <..hidden..> wrote:

Cost does not always stay the same--splits, dividends, and selling covered
calls can change original cost basis, so that needs to be updatable.

How do dividends affect cost basis?  I can't find any information on
that.  I would think that dividends (being drawing instead of capital
investment) would not affect cost basis.  I see some notes that they
do but I can't see anything about how or why.

It depends on the kind of company you're dealing with. Some dividends can be considered a return of capital. I'm not absolutely sure, but I think this happens in Master Limited Partnerships (MLPs - your usual oil/etc. pipeline company: they pay high dividends, often in the hood of 12%, but the tax headaches are manifold, so I currently avoid them). Examples: TCLP, PWE, APL, EPD. I believe it also happens with ETFs under certain circumstances, but I'm unclear on that. Examples: AGD, AOD.

Where I know it can happen, is in the case of REITs, which are something else income investers like. There, a portion of the dividend is qualified, a portion is unqualified, and a portion is return of capital, which effects your cost basis. Examples: NLY, CIM, CYS, FRT. It all depends on how they made and accounted for the money they used to fund the dividend, and I don't pretend to understand how that works. They publish what portion of the dividends throughout the year were in what classification, so you can't really tell, as I understand it, until as much as three quarters after receiving the dividend, how it is going to have been classified. A pain, but worth it if you like the yields.

"
Each year, REITs send Form 1099-DIV to their shareholders, containing a breakdown of the dividend distributions. For tax purposes, dividends are allocated to ordinary income, capital gains, and return of capital. As REITs do not pay taxes at the corporate level, investors are taxed at their individual tax rate for the ordinary income portion of the dividend. The portion of the dividend taxed as capital gains arises if the REIT sells assets. Return of capital, or net distributions in excess of the REIT's earnings and profits, are not taxed as ordinary income, but instead applied to reduce the shareholder's cost basis in the stock. When the shares are eventually sold, the difference between the share price and reduced tax basis is taxed as a capital gain.
"
(http://news.morningstar.com/classroom2/course.asp?docId=145579&page=2&CN=COM)

Luke