Capital Gains vs Dividends

Difference Between Capital Gains and Dividends

Capital gains are the gains which are realized when a capital asset is sold at a price which is higher than the cost which increase the profits of the company whereas dividend is any payment received from company which the company pays out of profits to its shareholders and which reduces the retained profits of the company.

They are two different forms of income that an investor earns over investments made in the Real estate (Capital gains) or Stocks (Dividends).

Capital-Gains-vs-Dividends

Capital gain is a rise in the value of the investment or real estate, which gives it a higher worth than the purchase price. This gain is not realized until the asset is sold. The dividend, on the other hand, is a portion of the earnings of a firm which is distributed to the shareholders as a reward. Let us analyze the differences between capital gains vs. dividends.

Capital Gains vs. Dividends Infographics

Let’s see the top differences between capital gains vs. dividends.

CAPITAL-GAINS-VS-DIVIDEND

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Source: Capital Gains vs Dividends (wallstreetmojo.com)

Key Differences

  1. Capital gain is the profit realized after selling off a long-term asset, whereas dividend is the income received from the profits of a company for the stakeholders.
  2. The occurrence of capital gain requires converting the share/asset into cash, whereas dividends can provide steady periodical income.
  3. The beneficiaries of capital gains are restricted to the owners and/or investors, generally few in numbers. However, the beneficiaries of dividends are usually enormous, which can run into thousands depending on the number of shares issuedShares IssuedShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more.
  4. Capital gains are taxed differently depending on if it’s long-term or short-term, whereas dividend is usually charged at a flat rate (e.g., 10%, 15%).
  5. Capital gains will generally occur once in the lifetime of the investor since the value is received upon realization. In contrast, Dividends can be distributed yearly depending on the decision making and policies of the senior management of the company.
  6. The amount of capital gain is generally on an increasing trend since it’s a long-term asset influenced by multiple macroeconomic factors. In contrast, the number of dividends can be erratic and depends on the performance of the company and the decisions of the management. It may be possible that they have had sufficient returns but may want to plow back an amount from the profits for investing in other activities of the firm.
  7. The decision to realize the capital gain rests in the hands of the owners/investors, but shareholders cannot control the timing and the number of dividends to be distributed.
  8. In terms of emoluments, capital gains do not offer anything additional apart from the fluctuations in the gain. Still, dividends can offer more in terms of bonus sharesBonus SharesBonus shares refer to the stocks issued by the companies for free of cost to their existing shareholders in the proportion of their stock holdings. Companies issue such shares to compensate the shareholders with a higher dividend payout in the form of stocks.read more, stock splits, etc.

Example

Let’s say if a property is purchased for $2,00,000 and if it’s sold for $2,75,000, the amount of capital gains shall be [$2,75,000 – $2,00,000 = $75,000]. The amount of taxation on the same will vary upon the time period if it has been held. Say, the asset has been sold after 3 years at a tax rate of 20%. The amount of tax shall be [20% * 75,000 = $15,000]

The tax treatment of capital gains can help in reducing the taxable income in a given year. If one has lost money on an investment and is considering changing investment strategy, the asset can be sold at a loss and receive a tax benefit from the losses incurred on the asset. It is never the primary reason to sell.

If a firm declares dividends @ $1.50 per share, then it will be multiplied by the number of shares held. Say Mr. A. is holding 12 shares of the firm, then he will get dividend = 12*1.50 = $18. It is to be noted that dividends may face double taxationDouble TaxationDouble Taxation is a situation wherein a tax is levied twice on the same source of income. It usually occurs when the same income is taxed both at corporate as well as at the individual level.read more since it is already taxed at the corporate level, and then further shareholders are charged dividend distribution tax at an individual level as well.

Capital Gains vs. Dividends Comparative Table

Basis of ComparisonCapital GainsDividend
MeaningIncrease in the value of a Long-term assetPart of the earnings distributed to shareholders
NecessityDepends on the macroeconomic factorsDepends on the decisions of the senior management
InvestmentA large investment is required for acquiring the capital asset to be eligible for capital gains.Relatively less investment for purchasing stocks
TaxationThe high amount of tax.The lower amount of tax is charged.
FrequencyRealized upon liquidationUpon LiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read moreOn a periodical basis, depending on policies.

Conclusion

The objective is to offer income to the investors on the principal amount invested by them. Since the amount earned can be volatile, it will attract the attention of the tax authorities and thus is required to be treated cautiously and in line with the investment objectives.

Both have a unique treatment in the U.S. tax code, and knowledge of incorporating these differences within the financial plan will help to utilize the money efficiently in the long-run. They can also help in tackling tax liabilities and reducing taxable income as well.

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