Re: Investment Addon

[Chris Travers <..hidden..>]

On Wed, Aug 10, 2011 at 2:33 AM, Luke <..hidden..> wrote:
> 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.

So is the idea here that these are limited term projects and hence the
dividend corresponds with a reduction in your expected return on
investment?
>
> 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.

Two questions:
1)  Is this a tax accounting issue or a financial accounting issue (I
realize there is a lot of overlap, but I would hate for us to hardwire
one country's tax logic too far into the application)?  In my view tax
logic and requirements should be modularized out so that we aren't
tied to one country's idiosyncracies.

2)  Is there somewhere you know of that I can go and understand the
financial accounting considerations of classes of dividends from
REIT's?

>
> "
> 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.

Ok, so this sounds like a tax accounting issue.  Any handling of
1099-DIV's should be abstracted from the core logic so we aren't tied
to just a US customer base.

> 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.

Ok, just consider that we don't want to build thins that are too
IRS-specific as part of the core module.  So I would suggest initially
breaking off 1099-DIV handling into a separate thing, and provide a
general mechanism for change in equity (preferably without updating
records in the database, so you have a paper trail).

Best Wishes,
Chris Travers