The tax treatment of a dividend in kind runs on two tracks at once: the distributing corporation is taxed as if it sold the property at fair market value, and the shareholder is taxed on that fair market value as a dividend to the extent the corporation has earnings and profits. Because no cash changes hands, both sides can end up with a tax bill and nothing liquid to pay it with, which is what makes property dividends harder to plan around than ordinary cash distributions.
What Counts as a Dividend in Kind
A dividend in kind, also called a property dividend, is any distribution a corporation makes to shareholders with respect to their stock in something other than cash. The code defines “property” broadly enough to sweep in securities, real estate, equipment, inventory, and promissory notes.1Office of the Law Revision Counsel. 26 U.S. Code 301 – Distributions of Property
One boundary worth flagging: a corporation’s own stock, or rights to acquire its own stock, is not “property” for these purposes. Stock dividends and stock rights follow a different set of rules and are not what this article covers.
How the Distribution Is Valued
Every downstream tax calculation flows from one figure: the fair market value of the property on the date of distribution. The code sets that as the “amount of the distribution” the shareholder is treated as having received.2Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property
Publicly traded securities are easy; you use the market price on the distribution date. Real estate, closely held interests, and specialized assets need an appraisal, and the IRS can challenge a valuation it considers too low, which would increase the taxable dividend for shareholders.
If the property carries a liability, such as a mortgage the shareholder assumes or that stays attached, the distribution amount is reduced by that liability. The net figure is what the shareholder is treated as having received.2Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property
How the Shareholder Is Taxed
Once you have the fair market value, a three-tier framework decides how it lands on the shareholder’s return. The tiers turn on whether the corporation has enough earnings and profits (E&P) to cover the distribution.2Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property
- Dividend income. The portion covered by current or accumulated E&P is a dividend and goes into gross income.3Office of the Law Revision Counsel. 26 U.S. Code 316 – Dividend Defined
- Return of capital. Anything beyond E&P is not a dividend; it reduces the shareholder’s stock basis, tax-free.
- Capital gain. If the non-dividend portion exceeds remaining stock basis, the excess is gain from the sale of the stock.
Most property dividends from profitable corporations land entirely in the first tier. The shareholder cannot substitute the corporation’s original cost for fair market value; the FMV number controls.
Qualified Versus Ordinary Rates
Qualified dividends are taxed at long-term capital gains rates of 0%, 15%, or 20% depending on taxable income.4Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Dividends that don’t qualify are taxed as ordinary income at rates up to 37%.
To qualify, the shareholder must have held the stock more than 60 days during the 121-day window beginning 60 days before the ex-dividend date. Property dividends from domestic C corporations generally qualify when that holding period is met, but distributions from certain foreign corporations or on certain preferred stock may not.
The 3.8% Net Investment Income Tax
Dividends count as net investment income, and high-income shareholders owe an extra 3.8% surtax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly).5Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Those thresholds are not indexed for inflation. A large property dividend can easily push a shareholder over the line and add 3.8 percentage points to the effective rate.
Basis in the Property Received
Whatever the corporation originally paid for the asset, the shareholder’s basis in it is its fair market value on the distribution date.1Office of the Law Revision Counsel. 26 U.S. Code 301 – Distributions of Property The holding period for the received asset also starts on the distribution date, because the basis is fair market value rather than a carryover from the corporation.
How the Corporation Is Taxed
The distributing corporation is treated as though it sold the property to the shareholder at fair market value immediately before the distribution. If FMV exceeds the corporation’s adjusted basis, the corporation recognizes that difference as taxable gain.6Office of the Law Revision Counsel. 26 U.S. Code 311 – Taxability of Corporation on Distribution
The character of the gain depends on the asset. Distributing subsidiary stock typically produces capital gain. Distributing depreciable real property can trigger depreciation recapture, converting some or all of the gain into ordinary income taxed at the full corporate rate.7Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
Losses Are Not Recognized
The rule cuts one direction only. If the distributed property has fallen below the corporation’s basis, the corporation cannot recognize the loss. The loss disallowance for non-liquidating distributions is absolute.6Office of the Law Revision Counsel. 26 U.S. Code 311 – Taxability of Corporation on Distribution A corporation sitting on a depreciated asset it wants to move out is generally better off selling it, taking the loss, and distributing the cash.
Effect on Earnings and Profits
A property dividend adjusts E&P in two steps. Gain recognized on the deemed sale increases E&P first, then the fair market value of the property distributed reduces it.8Office of the Law Revision Counsel. 26 U.S. Code 312 – Effect on Earnings and Profits
The order matters. Because the gain hits E&P before the distribution comes out, the distribution is more likely to be fully covered by E&P and taxed as a dividend to shareholders. A corporation distributing land with a $50,000 basis and a $150,000 fair market value adds $100,000 of gain to E&P first, and only then reduces E&P by the $150,000. Without that sequencing, the corporation might not have had enough E&P to make the whole distribution a dividend.
S Corporations
S corporations follow the same gain-recognition rule when distributing appreciated property. The corporation is treated as selling the property at fair market value, and the gain passes through to all shareholders in proportion to ownership, not just the one who received the asset.9Internal Revenue Service. Property Distribution Practice Unit Shareholders who received nothing still pick up their share of the gain on their individual returns.
The distribution itself is then run through the S corporation distribution rules rather than the C corporation three-tier framework. If the S corporation has no accumulated E&P from a prior C corporation life, distributions are first a tax-free return of stock basis, with any excess as capital gain. If accumulated E&P exists from prior C corporation years, the ordering rules become more involved and part of the distribution can be taxed as a dividend out of that older E&P layer.
Reporting and Filing
A corporation that distributes property must file Form 1099-DIV for each shareholder who received $10 or more in dividends or distributions during the year, whether the payment was cash or property.10Internal Revenue Service. Instructions for Form 1099-DIV The property’s fair market value is reported in the same ordinary or qualified dividend box a cash payment would use.
If any part of the distribution exceeds current and accumulated E&P, the corporation also attaches Form 5452, Corporate Report of Nondividend Distributions, to its income tax return for the year of the distribution.11Internal Revenue Service. Corporate Report of Nondividend Distributions (Form 5452) S corporations file it when distributions exhaust accumulated E&P or when the special S corporation distribution provisions apply.
Shareholders report the 1099-DIV amounts on their individual returns. When part of a distribution is a return of capital, the 1099-DIV will not adjust stock basis for you; you need to reduce basis yourself and keep the records for the year you eventually sell the stock.