Get Rich with Dividends: A Proven System for Earning Double-Digit Returns

Avoid the Tax Man

For example, you buy a fund for $10 and receive $1 in distributions that are all return of capital (none of it is classified as a dividend). Generally speaking, you will not pay any income tax on the $1 distribution this year. Instead, your cost basis will decrease from $10 to $9. When you eventually sell the stock, you will be taxed as if you bought it at $9.

Every time you receive a return of capital distribution, your cost basis will be lowered.

Some of these buy-write funds pay a large distribution that is classified as a return of capital, but it’s not quite as I described it, where an investor receives her own money back.

When a company sells an option against a stock and collects the premium, the premium paid out to investors also is considered a return of capital. The option premium is not classified as a capital gain. The fund didn’t sell a stock for a gain in order to generate that cash to pay the dividend. Therefore, the distribution is considered a return of capital, enabling investors to enjoy some tax-deferred income.

Boxing, the Stones and Taxes

I know about a lot of things. Ask me anything about boxing (Joe Louis was the greatest heavyweight champion), the Rolling Stones (“She’s So Cold” is the most underappreciated Stones song), and the stock market (buy low, sell high). One subject I don’t profess to be an expert on is taxes. Consult your tax professional with any questions specific to your situation.

One last note about closed-end funds: ...