# Understanding Return of Capital (ROC): Tax Implications and Examples

> **Definition**
>
> Return of capital is a payment that returns a portion of an investor's original investment.

## What Is Return of Capital (ROC)?

Return of capital (ROC) is a payment, or return, received from an investment that is not considered a taxable event and is not taxed as income.

Return of capital reduces an investor's [adjusted cost basis](https://www.investopedia.com/ask/answers/041015/what-adjusted-cost-basis-and-how-it-calculated.asp) and is not considered [capital gains](https://www.investopedia.com/terms/c/capitalgain.asp) from the investment. It's nontaxable until the cost basis is reduced to zero, at which point any subsequent return will be taxable as a capital gain.

Common ROC scenarios or investments include retirement accounts and real estate investment trusts (REITs).

While return of capital is a nontaxable repayment of your original investment, income and capital gains are taxable earnings and profits from that investment. This distinction is important for tax planning, because it affects when and how much tax you pay.

### Key Takeaways

*   Return of capital (ROC) payments are not taxable, as they represent the return of an investor's original principal, reducing the investment's adjusted cost basis.
*   Once the adjusted cost basis of an investment reaches zero, any further distributions are taxable as capital gains.
*   ROC differs from return on capital, with the former being a return of the original investment and the latter indicating the return earned on that investment.
*   Investments like 401(k) plans or IRAs may allow investors to receive their capital back before gains, affecting the tax implications.
*   Maintaining an accurate track of an investment's cost basis is crucial for identifying ROC payments and managing potential tax consequences.

![Return of Capital](https://www.investopedia.com/thmb/tawoWKuxpluyKQNORVkcQqfrAn8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/returnofcapital.asp-final-e81e1adae6ed454694a89a15d6590b88.png)

*Investors and financial advisors should track the cost basis of each investment so that any return of capital payments can be identified. — Jessica Olah / Investopedia*

## Understanding the Mechanics of Return of Capital

When an individual invests, they put the [principal](https://www.investopedia.com/terms/p/principal.asp) to work in hopes of generating a return—an amount known as the [cost basis](https://www.investopedia.com/terms/c/costbasis.asp). When the principal is returned to an investor, that is the return of capital. Since it does not include gains (or losses), it is not considered taxable—it is similar to getting your original money back.

> **Important**
>
> Return of capital should not be confused with return on capital, where the latter is the return earned on invested capital (and is taxable).

Some types of investments allow investors to first receive their capital back _before_ receiving gains (or losses) for tax purposes. Examples include [401(k) plans](https://www.investopedia.com/terms/1/401kplan.asp), [individual retirement accounts (IRAs)](https://www.investopedia.com/terms/i/ira.asp), and cash from permanent life insurance policies. These products are examples of [first-in, first-out (FIFO)](https://www.investopedia.com/terms/f/fifo.asp) because investors receive their first dollar back before touching gains.

[Cost basis](https://www.investopedia.com/terms/c/costbasis.asp) is defined as an investor’s total cost paid for an investment, and the cost basis for a stock is adjusted for [stock dividends](https://www.investopedia.com/terms/s/stockdividend.asp), [stock splits](https://www.investopedia.com/terms/s/stocksplit.asp), and the cost of [commissions](https://www.investopedia.com/terms/c/commission.asp) to purchase the stock. It is important for investors and financial advisors to track the cost basis of each investment so that any return of capital payments can be identified.

When an investor buys an investment and sells it for a gain, the taxpayer must report the capital gain on a personal tax return, and the sale price less the investment’s cost basis is the capital gain on the sale. If an investor gets less than or equal to the cost basis, it is a return of capital, not a capital gain.

> **Fast Fact**
>
> Some dividends from real estate investment trusts (REITs) are considered a return of capital, since investors get their invested funds back. Although they are not taxed, these dividends reduce the cost basis in a REIT investment.

## Illustrating Stock Splits With Return of Capital

Imagine an investor buys 100 shares of XYZ stock at $20 each, and a 2-for-1 stock split doubles the holdings to 200 shares at $10 each. If the shares are sold for $15 each, the first $10 is a nontaxable return of capital. The additional $5 per share is a capital gain and is reported on the personal tax return.

## Navigating Return of Capital in Partnerships

A partnership is defined as a business in which two or more people contribute [assets](https://www.investopedia.com/terms/a/asset.asp) and operate an entity to share in the profits. The parties create a [partnership](https://www.investopedia.com/terms/p/partnership.asp) using a partnership agreement. Calculating the return of capital for a partnership can be difficult.

A partner’s interest in an entity is tracked in the partner’s [capital account](https://www.investopedia.com/terms/c/capitalaccount.asp), and the account is increased by any cash or assets contributed by the partner along with the partner’s share of profits. The partner’s interest is reduced by any withdrawals or guaranteed payments and by the partner’s share of partnership losses. Withdrawal up to the partner’s capital account balance is considered a return of capital and is not a taxable event.

Once a partner's capital account is fully paid, additional payments are treated as taxable income.

## What Is the Difference Between Capital Dividends and Regular Dividends?

Return of capital is also called [capital dividend](https://www.investopedia.com/terms/c/capital-dividend.asp). The term refers to a payment that a company makes to its investors and that is drawn from its paid-in-capital or shareholders' equity. By contrast, regular dividends are paid from the company's earnings.

## How Is Return of Capital Taxed?

Return of capital distributions are not subject to tax. However, once the adjusted cost  
basis of the stock is reduced to zero, any non-dividend distributions are considered to be a taxable capital gain.

## What Is the Difference Between Return on Capital and Return of Capital?

Return _on_ capital is the annual return you earn from an initial investment, and it's taxable. Return _of_ capital is the rate at which an initial investment can be recouped.

## The Bottom Line

Return of capital (ROC) is a nontaxable return of a principal investment. It reduces an investor's adjusted cost basis, but it can lead to taxable capital gains once the cost basis reaches zero.

Return of capital can be easily confused with dividends, but these two types of distributions function differently. ROC distributions are taken from its paid-in-capital or shareholders' equity, whereas dividends are paid from the company's earnings.

Return of capital is also distinct from capital gains because it is a repayment of your original investment, not a profit. Capital gains are a realized profit from selling an asset for more than its purchase price.

Examples or applications of ROC in investment types include retirement accounts (401(k)s and IRAs), cash from permanent life insurance policies, and some REIT dividends.  

It's important to track cost basis adjustments to avoid surprises in taxable capital gains.