Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Tutoring
  • Home
  • Accounting, Taxation, and Reporting
  • Business Taxation

Return of Capital - Explained

What is a Return of Capital?

Written by Jason Gordon

Updated at April 8th, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is Return of Capital?How Does Return of Capital Work?Key points to RememberExample of Stock Splits and Return of CapitalFactoring in Partnership Return of CapitalAcademic Research on Return Of Capital

What is Return of Capital?

Return of capital refers to a return that an investor receives of the amount invested, and is excluded from the taxable income category. It takes place when an investor gets a percentage of his or her actual investment, and such proceeds are not included in the income or capital gains from the investment category. It would be important to know that a return of capital decreases the adjusted cost basis of an investor. After the adjusted cost basis of the stock reaches zero, any following return will be treated as capital gains. Important: Return of capital is different from return on capital that involves the rate of return received on the investment made, and comes under the taxable category.

Back to: Accounting & Taxation

How Does Return of Capital Work?

An investor invests in order to receive a return at a later date. The initial amount or principal invested is called the cost basis. When the investor receives the principal amount back, it is known as a return on capital. As it excludes any profits or losses, it is not taxable. It is mostly like receiving your actual amount back. There are some investments that offer investors capital back prior to gaining any profits or losses for taxation. Qualified retirement plans such as 401(k) or IRA are fine examples of FIFO or first-in-first-out method where the person gets the dollar first prior to gaining profits. Cost basis refers to the total amount that an investor contributes towards an investment. Adjustments can be made in case of stock dividends and stock splits, expense of commission for buying the stock. Financial advisors as well as investors should keep a record of the investments cost basis so as to ascertain the return of capital payments. An investor who sells a stock, and earns profits thereon should report the capital gains while filing personal tax. Capital gain can be calculated by subtracting the cost basis of an investment from its sale price. If the amount received is equivalent or lower than the cost basis, that payment is a return of capital, rather than capital gain. 

Key points to Remember

  1. Return of capital refers to the amount paid or return that an investor receives from an investment which is not taxable.
  2. Return of capital takes place when an investor obtains a specific proportion of actual investment, and such payments dont make a part of income or capital gains.
  3. Some investments such as retirement accounts and long-term insurance policies get some capital back before anything else. One can expect receiving gains first from regular investment accounts.

Example of Stock Splits and Return of Capital

Lets say an investor purchases 100 shares of ABC common stock for $20 per share. The stock offers a 2-for-1 stock split so as to make the adjusted holdings of investor for 200 shares at $10 for each share. When he sells shares at $15, the initial $10 will be treated as a return of capital and wont be taxed. The remaining $5 per share will be considered a capital gain and will be recorded as personal tax return.

Factoring in Partnership Return of Capital

Partnership refers to a form of business where a minimum of two persons combine assets and do profit-sharing while operating the business. Parties formulate a partnership deed, and may find it difficult to calculate return of capital in a partnership agreement. The capital account of the partner showcases the interest of a partner in a partnership firm. If any cash or assets are offered by a partner, it results in increase in capital account as well as the percentage of profits. The interest of partner can be decreased when any amount is withdrawn from the account as well as the losses incurred. Any withdrawal that is made up to the capital account amount of the partner is non-taxable and is treated as a return of capital. After the partner receives the total capital account balance, any excessive payments are treated as partners income and are taxable on the personal income tax return of the partner.


return of capital

Was this article helpful?

Yes
No

Related Articles

  • Step Up in Basis - Explained
  • Tax Basis (Business) - Explained
  • Estimated Taxes - Explained
  • GUST Restatement - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand