Dividend stripping involves buying stocks before the issuer pays dividends and selling them after, historically used for tax breaks. It can result in a net loss if the price of securities falls sharply. Some countries have made changes to their tax codes to curb this practice. Institutions can use dividend stripping on a large scale to offset risks.
Dividend stripping is a stock trading practice in which people buy stocks just before the issuer pays dividends and sell them after the payout. Investors have historically used this tactic to get tax breaks, and some nations have made changes to their tax codes to close the loophole that previously allowed people to do so. Individual investors and institutions alike can engage in dividend stripping, and in cases where no tax benefits are contemplated, there may be other reasons to manage stocks in this manner.
At the time of purchase, stocks are usually priced high because people anticipate dividends. By the time the shareholder goes to sell them, they have usually lost value. This may allow the shareholder to declare a loss after the sale of the securities. The loss offsets the capital gain realized by the shareholder from the distribution of the dividend. When people do dividend stripping well, they can make a profit without having to pay high taxes, if the tax system allows them to do so.
People need to be careful when engaging in dividend stripping. If the price of the securities falls sharply, the income from the dividends may not be sufficient to compensate for the loss from the sale, or the investor may barely break even. After factoring in the costs associated with buying and selling securities, the move could result in a net loss, rather than a gain. Investors can consider the historical performance of these securities, as well as consider whether they might hold onto them if they fall sharply in value.
Some nations recognize dividend stripping as a tax avoidance strategy. To curb it, they don’t allow people to claim losses on assets they only hold for a short time. For example, someone who buys stocks on Monday and sells them on Friday at a loss cannot claim a loss. Usually, people need to hold securities for at least three months before they can sell them at a loss and claim them on their taxes. Strategic investors may be able to hold onto securities that long, while others may not.
Institutions can use dividend stripping on a very large scale, buying huge volumes of stocks. This can offset the risks, as a failure to do well with one stock will cancel out when weighed against successful investments with others. Analysts and buyers at institutions make decisions about the type of transactions they wish to proceed with and when, timing the purchases and sales for the most advantageous time.
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