A disposition involves the act of selling or otherwise ‘disposing’ of an asset or security. The most typical form of a disposition is selling a stock investment on the open market, like a stock exchange.
Other types of dispositions include donations to charities or trusts, the sale of real estate (whether land or buildings), or any other financial asset. Additionally, dispositions can involve transfers and assignments, ultimately relinquishing the asset from the investor’s possession.
Key Takeaways
- A disposition generally refers to selling securities or assets on the open market.
- Dispositions can include transfers or donations to charities, endowments, or trusts.
- For business dispositions, the SEC necessitates specific reporting depending on the nature of the disposition.
- Donations, assignments, or transfers can often be utilized for beneficial tax treatment.
Delving Deep into Disposition
The phrase ‘disposition of shares’ is frequently used regarding a disposition. For instance, if an investor has held shares of a particular company for a long time but the company’s performance declines, deciding to exit the investment equates to a disposition of shares. This usually involves selling the shares through a broker on a stock exchange, essentially disposing of the investment.
If this sale results in a capital gain, the investor will owe capital gains tax on the profits, subject to IRS regulations.
Other disposition forms involve transfers and assignments, where one legally transfers specific assets to family, a charity, or an organization, often for tax or accounting purposes, reducing the tax or other liabilities for the disposer.
For example, if an investor acquires stock for $5,000, which then grows to $15,000, donating it to a charity can avoid capital gains tax on the profit, allowing the entire $15,000 to be included as a tax deduction.
Dispositions in Business
Businesses frequently dispose of assets and entire segments or units, often known as divestiture. This can occur via a spinoff, split-up, or split-off. The SEC has stringent guidelines on reporting and handling these transactions. Failing to report a disposition in a company’s financial statements may necessitate pro forma financial statements if the disposition meets a significance test.
Significance is determined using either an income or investment test. An investment test considers the investment’s value in the disposed segment compared to total assets, deeming it significant if over 10% at the most recent fiscal year-end. The income test measures if the ’equity in the income from continuing operations before taxes, extraordinary items, and cumulative effects of changes in accounting principles’ exceeds 10% of such income at the most recent fiscal year-end, with thresholds sometimes extended to 20%.
Understanding The Disposition Effect
Behavioral economics touches on the inclination to sell winning versus losing positions, rooted in loss aversion. The ‘disposition effect’ describes this phenomena wherein investors prematurely sell winning investments, missing full potential gains, while clinging to losing investments longer than advisable, hopeful for a turnaround.
Introduced by Hersh Shefrin and Meir Statman in 1985 in
Related Terms: investment, capital gain, divestiture, shareholder, tax deduction.
References
- The National Law Review. “SEC Amends Financial Statement Requirements for Business Acquisitions and Dispositions”
