Unit 20: Investment returns

Wash sale rules

1. the rule applies to re-creating long/short positions

Two years ago John Henry sold short 100 shares at $50 per share, and two years later bought them back for $55 per share. The stock paid a $2.50 dividend each year. How much did John gain or lose per share for tax purposes?

The formula to calculate a gain or loss for tax purposes is the proceeds minus the cost basis. John bought the shares at $55 and sold at $50. The dividends are not included in the calculation of gain or loss for tax purposes.

DJIA

Tracks the stocks of 30 of the largest American companies to measure the well-being of the stock market as a whole

Barclays Capital U.S. Aggregate Bond Index

Use this index to compare the performance of bonds.

Yield

a measurement of the amount on income an investor will receive as a % of the cost of the investment.

Formula for yield:

annual income $$ / current market value = current yield

Ex-dividend date for a mutual fund is

the day after the record date

wash sale rule #2

-applies for attempts to recreate the same position using not only the exact same security but also substantially identical securities.

Example of yield: MGM Corp. pays a 0.25 quarterly dividend. MGM is trading at $20 a share. What is the current yield of the stock?

0.25*4 (four quarters in a year)/20 = 0.05 (5%)

Mr. Ross purchased 100 shares of AAL for $20/share. After 1 year, he sold it for $21/share. Over the year, the company paid 25 cents/quarter. What is his total return?

0.25*4=$1 in income Sold the stock for $1 gain. $1 income + $1 gain = $2 2/20=0.1 (10%)

Which of the following would not be considered ordinary income for tax purposes? 1. Gains gotten from the sale of securities 2. Dividends on common stock 3. Salary and commissions 4. Rents from income properties

1. Gains gotten from the sale of securities is an example of capital gains for tax purposes. All the others are considered ordinary income.

Order for mutual funds:

1. declaration date 2. record and payable date 3. ex-dividend date

Three types of ordinary income

1. earned income 2. investment income 3. passive income

QUIZ Q: An investor purchased 100 shares of LMN in 2013 at a price of $40 per share. Soon after, the LMN declared a 25% stock dividend. Three years after the shares were purchased, they were sold at $50. Which of the following statements are correct? 1. The adjusted cost basis of the shares is $30. 2. The adjusted cost basis of the shares is $32. 3. There is a short-term capital gain on all the shares sold. 4. There is a long-term capital gain on all the shares sold.

2 and 4 When a company declares a stock dividend, the cost basis per share is always reduced. The customer will receive 25 new shares (100 shares × 0.25 = 25). The computation is the original total cost $4,000 (100 × $40) divided by the new number of shares 125 (100 + 25). Four-thousand dollars divided by 125 shares equals a new cost basis per share of $32. The holding period for capital gain or loss (short or long term) is always from the original purchase date. In this case, because the shares were sold three years later at 50, the gains are long term.

Wilshire 5000

An index that includes stock prices from 5,000 companies. That's nearly every company traded in the United States

Realized capital gain

If you sell MGM for $25 from $20, then taxes are due

An investor has a long position in OMQ stock. After selling the stock at a loss, the investor could purchase which of the following and not violate the wash sale rule?

In order to avoid violating the wash sale rule, investors selling a stock at a loss cannot purchase that same, or substantially identical, security within a 30-day period before or after the sale incurring the loss. Substantially identical would include anything that is exercisable or convertible into the same shares of stock, such as rights, warrants, call options, or a convertible bond. Purchasing the put options would not violate the wash sale rule because these can be exercised to sell the stock, not purchase it.

Unrealized gains and losses are found on open positions. No tax impact.

MGM bought at $20, goes up $25. Unrealized is $5. Just a gain. nothing else

Lipper Indexes track what

Mutual funds

Who sets the ex-dividend date for mutual funds?

Set by the fund's board of directors, not FINRA or an exchange.

When a customer purchases mutual fund shares the transaction is directly with the fund,

So the trade is settled the day it is executed.

MSCI EAFE Index

The Europe, Australia, and Far East Index, a value-weighted index of the equity performance of major foreign markets

When a bond is purchased at a discount the current yield will be

The coupon rate, the stated rate, the fixed rate, and the nominal rate all mean the same. It is the amount the bond will pay each year. On a discount bond the current yield is always higher than the coupon rate.

An investor notices that a bond purchased several years ago at 95 is now priced at 90. The investor sells the bond for 90, then immediately repurchases it for 90. This action is known as

The investor's intent with this wash sale is to declare a $50 capital loss without changing positions on the bond. Immediate repurchase is not illegal, but it precludes declaring the loss for tax purposes. The investor must wait at least 30 days before buying the bond back, or the loss will be disallowed.

Example of adjusting a cost basis:

Your customer purchased 100 shares of MGM for $22 a share 3 years ago. Last week they sold the 100 shares for $25 a share. sales proceeds (2,500) - cost basis (2,200) = $300 gain

Total return

a measure of the return an investor receives from an investment that includes both income and any gain/loss realized. expressed as a % of the cost basis of the investment

Wash sale

an attempt to create a loss for tax purposes (sell at a loss) when one''s intent is to still maintain ownership of the securities. Any repurchase of the same stock within 30 days before/after the date, it means the owner still wants ownership of the stock.

Current yield

applies to both stocks and bonds. If the income is from a stock dividend, it's also called dividend yield.

An investor has been putting aside funds for retirement in a nonqualified variable annuity for over five years. She is now age 66 and takes a lump-sum distribution. How are the earnings taxed?

as ordinary income With a nonqualified annuity, all distributions more than the cost basis will be taxed as ordinary income.

Ordinary income

consists of several different types of income that are added together to determine ordinary income. It is used to determine the income tax rate that an investor pays for.

Passive income

direct participation programs like limited partnerships and many real estate investments. can produce passive losses/income. A taxpayer who has passive losses in a given year may use losses to offset any passive income received that tax year.

Formula for calculating total return:

dividends + gains (-losses) / amount invested = total return

Investment income (portfolio income)

earned from one's investments. Dividends, interest payments.

Regarding the taxation of gains on securities, all of the following are true except

gains on securities for a position held at least 12 months are not taxable. Investment income, which includes capital gains realized on securities positons, is taxable. Depending on how long a security was held, the gains might be taxable at the investor's ordinary income tax rate (for short-term gains) or at a more favorable long-term rate if the position was held for longer than 12 months.

Capital gains

generated from closing an open position at a profit. If you close an open position for a loss, you have capital losses.

S&P 500

index that shows the price changes of 500 different stocks

Short term capital gains

made from assets held for a period of 1 year or less. Taxed as ordinary income.

Long-term gain

must be held for more than a year.

Mutual fund shares become owners of record

on the day the buy takes place.

Sellers of mutual funds end their ownership

on the day the trade takes place.

Short term gain

one year or less

Earned income

salary, wages, bonuses, tips, and other income that is derived from active participation in a trade/business.

Formula for capital gains/losses:

sales proceeds - adjusted cost basis = (capital gains+/capital losses -)

If an investor still has losses in excess of gains and the $3k,

she may carry those losses into the next tax year. aka carryforward losses, no time limit

Russell 2000 index

specialty index that uses 2,000 stocks to measure the performance of the smallest U.S. companies

All of the following are taxable to the investor except 1. stock dividends. 2. capital gains distributions. 3. cash dividends. 4. semiannual interest payments.

stock dividends

Long term capital gains

taxed at an advantages rate. The actual rate is not tested because it changes alot. It's always lower than the investor's ordinary income tax rate.

For tax purposes, investment income is

taxed at either ordinary income tax or capital gains tax rates. Investment income is that which is earned from one's investments. Sometimes called portfolio income, it would include dividends, interest, and capital gains derived from the sale of securities. For tax purposes, investment income will generally be taxed at one of two rates: ordinary income tax rate or capital gains tax rate.

Adjusted cost basis is

the amount paid for a position modified by any adjustments. The effect of a stock dividend is an example of adjusting a cost basis.

When is dividend no longer available to new owners?

the day after the record date.

on test: use of capital losses

used to offset capital gains on a dollar for dollar basis. If an investor has losses that exceed gains in a given year, she may use up to $3k of those losses to reduce ordinary income.