Next, you need to look at your Form 1099 reports since the date of purchase and see if any of the dividends paid by the company were classified as "return of capital" payments for tax purposes. Also referred to as "return of principal" payments, these amounts reduce your cost basis.
Return of capital payments are often seen in the cases of utility stocks, real estate investment trusts, or corporations which are paying dividends in excess of their earnings and profits.
You are required to apply the return of capital to each tax lot separately. You cannot choose to apply it only to your high cost basis tax lots. You may end up with some tax lots where the cumulative return of capital payments exceed your original cost basis per share. In that case, you are required to recognize any excess return of capital payment for that tax lot as a capital gain distribution.
Click on the image below to access our free Return of Capital Calculator
Return of Capital Calculator
Here is a detailed example:
You bought 500 shares of Servicemaster at $13.00 per share on 1/31/2006, for a total cost of $6,500.00.
On your Form 1099 report from your brokerage firm, you find that the following return of capital payments have been reported from Servicemaster:
For 2006: $200.00 ($0.40 per share) For 2007: $120.00 ($0.24 per share)
You did not pay any income taxes on the return of capital payments.
On 7/18/2007, you sold all of your Servicemaster shares for $7,780.00.
What is your cost basis and related gain or loss?
You do not have to declare a capital gain distribution for the return of capital payment because the cumulative amount of $0.64 per share is less than your cost basis per share of $13.00 for the one tax lot that you own.
Your new cost basis is your original purchase price of $6,500.00 less the return of capital payments of $200 and $120 received in 2006 and 2007. Thus, your adjusted cost basis is $6,180.00 and your capital gain is $1,600.00 ($7,780.00 less $6,180.00).
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Information provided is intended solely for U.S. individual cash-basis taxpayers and is believed to be accurate for most cases. Always consult your personal tax advisor about your own situation. Suggestions are most welcome. Please e-mail webmaster @ costbasis.com or write to us at P O Box 11022, Chicago IL 60611 with your comments.