What is a Distribution-in-Kind?
Distribution-in-kind, also known as a distribution-in-specie, is a payment that is not made in cash. Instead, it is a payment that can be made in the form of physical goods or any other financial instrument that is not cash.
For example, payment can be made using securities, such as stocks, dividends, bonds, or mutual funds. It can also be in the form of inheritance, such as property, investments, or any other asset that is not cash. It is beneficial to pay out a distribution-in-kind in cases where cash may not be easily accessible or in situations where it is more practical to execute a payment using a physical asset instead of cash.
When an individual makes a distribution-in-kind, there are a few key points for consideration. The process of transferring a physical asset or an alternative financial instrument may require them to fill out forms at the bank. They can specify if they want to take a portion of the asset in-kind and another portion in cash.
Making Use of a Distribution-in-Kind
A distribution-in-kind is useful because it is a flexible and convenient option for individuals to be paid, especially if the asset is not easily liquefiable. For investors, it is a preferred method for transferring funds if they want to avoid going through the process of cashing out their stocks.
For companies that need to pay out dividends to their investors, they can opt to pay dividends by giving out more shares of stocks rather than cash. For family members who are receiving property as an inheritance, it is also a favored way of receiving payment instead of having to sell the property to receive cash.
A distribution-in-kind sometimes leads to more favorable tax outcomes. Businesses and organizations may prefer to use a distribution-in-kind to minimize the amount of taxes they need to pay and to avoid paying the capital gains tax that comes from an increase in the value of an asset.
Besides businesses, private investors who keep tax-deferred accounts may also opt to use a distribution-in-kind because it helps decrease taxes. Additionally, investors also prefer a distribution-in-kind because they can record the profit they earn from stocks as part of capital gains rather than ordinary income. It is advantageous to the investor because ordinary income is taxed at a higher rate than capital gains.
Although a distribution-in-kind can be used to offset or mitigate the amount of payable taxes, there is an exception for transactions involving real estate. If a property is sold and the homeowner earns a profit from the sale, then the amount that he/she earns is not exempt from the capital gains tax.
Example of Using a Distribution-in-Kind
In the United States, individuals who are of retirement age are required to withdraw a certain amount of money annually from their individual retirement account (IRA) and/or retirement plans from their employer. The amount that they withdraw is called the required minimum distribution (RMD), and it must be taken out of their account to avoid tax penalties.
However, the amount that they take out does not need to be in the form of cash. Instead, they can withdraw the RMD in-kind because doing so allows them to transfer the securities into a taxable account. Moving your securities to a taxable account means that if your securities go up in value due to appreciation, then the profit that they can earn will be taxed as capital gains rather than ordinary income. It is beneficial because the capital gains tax is lower than the ordinary income tax rate.
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