How to Cash In on a Special Dividend

Besides regular dividends – most often quarterly – companies sometimes pay special one-time dividends. These extra dividends typically are rare, sparked by a series of exceptional earnings reports, large cash reserves, a major litigation win, or selling or restructuring part of a company. Special dividends tend to be considerably larger than regular ones, and they might be distributed as cash or additional stock shares. If you don't already own company shares, deciding whether to react to a special dividend announcement depends on your investing time horizon. Older investors may want to position themselves to collect the extra payment, but younger ones might get an attractive buying opportunity after the special dividend is paid.

Find the ex-dividend date. When the company announces its special dividend, it also will issue the record date – the date by which you must be a shareholder to collect the dividend. The exchange where the stock is traded sets the ex-dividend date, usually two trading days before the record date, but sometimes three days for a special dividend. Check the date at the investor-relations section of the company's website. You must own the stock before the ex-dividend date to meet the company's date of record.

Calculate tax implications. Cash dividends, including special dividends, from most U.S. companies qualify for a top tax rate of 15 percent – or tax-free if your adjusted gross income puts you in the 10 or 15 percent tax bracket. However, if the company classifies a special cash payment as return of capital, the dividend carries no immediate tax implications. Instead, your tax basis goes down, which affects your tax liability only when you sell the stock. Let's say you bought 100 shares of Good Company for $1,000. When it issued a $100 special dividend as a return of capital, your tax basis would drop to $900 for your 100 shares. If you sell the stock at a profit, you would owe capital gains tax – 15 percent for long-term gains – on an extra $100 in tax basis.

Monitor the stock price effect. After a special dividend announcement, expect the stock price to rise as investors buy shares to collect the special dividend. However, the share price likely will fall on the ex-dividend date. In an efficient market, the share price would fall by the amount of the dividend as the company's value is reduced by the amount of cash paid to shareholders. However, other factors, including either negative or positive speculation, also affect a stock's marketplace price. Check the stock's price on, and immediately after, the ex-dividend date by entering the stock's symbol on market websites such as MarketWatch and Yahoo Finance.

Harvest the dividend. You can expect a price spike immediately after the announcement, then a price pullback as some shareholders sell, choosing to take capital gains rather than the special dividend. However, if you really want to grab the special dividend, be careful about trying to squeeze out the absolute best price. Other buyers also will seek the dividend, so the price will be volatile, and you could miss out completely if your limit price is too low.

Buy the dividend dip. After the ex-dividend date, the price could fall further. This decline may be more than the extra dividend payment might suggest, as some long-term shareholders also take profits after the special dividend. Younger investors with a long view can find an excellent opportunity to buy a strong company generating surplus cash at a bargain price.

Tips

  • For a dividend payment to qualify for the 15 percent tax rate, you must hold the stock more than 60 days of the 121-day period that begins 60 days before the ex-dividend date.
  • Special dividends paid as stock distributions typically do not trigger immediate tax liability. Instead, you will lower your per-share tax basis. For example, if Good Company paid a special dividend of 1 share for every 10 shares owned, boosting your share total to 110 shares, your total tax basis would remain $1,000. But the per-share price would drop from $10 each to $9.09. A company usually reveals the tax structure of a stock dividend payment in its announcement.
 

About the Author

Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.