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Return of capital occurs when an investor receives a portion of their original investment that is not considered income.
Many of the funds I own and preach about on this channel, like Income Funds, Split Share Funds, Covered Call ETFs and even REITs can classify a portion of their dividend they give out as ROC. (it can be a small portion or a big portion, it varies from fund to fund)
I'm getting more and more questions about this because many of you are afraid and have very negative thoughts about ROC income. People think that it’s simply your own money being returned to you (like some sort of Ponzi scheme) and that these dividends are eroding the funds NAV, or simply the overall value of the fund
Some people even think that funds that give out a high % of ROC income year after year will basically drive the price of the Stock to zero!

First of all, it's important to understand that ROC is 1 of the 4 tax classifications that investment income can fall under. There is Interest Income , Dividends, Capital Gains and finally ROC Income.
Out of the 4 ROC income is taxed the least at 0$
Makes sense right because like the definition says, it’s a portion of capital being returned to you. Which is another way of saying that it’s a portion of your original investment returned to you. So of course it’s not taxed… it’s not considered Income on paper.

So what does ROC income actually do? Well it lowers your ACB. So if ever you want to sell the stock or fund in the future, you need to ensure you factor that in.
Here is an easy example:
Let’s say you Invested in Stock ABC at 10$ Let’s say that it has an Annual Dividend of 1.20$/share or 10 cents a month.
Let’s also assume that all the dividends are classified as 100% ROC.
After a year you get 1.20$/share in Dividends right?
Let’s say you want to sell this Fund now, after collecting 1 year of dividends and that the Stock price of the fund is still 10$. You might think well i broke even, so no capital gains taxes to pay right?
Wrong...
Because your ACB is not 10$ anymore, it’s 10$-1.20$ so it’s 8.80$. Which means if you sell it, you need to pay Capital Gains because it’s as if you bought the stock for 8.80$ now and not 10$. As simple as that.

Another thing I want to point out is that many Funds give out ROC income. Not only Closed end funds (which i usually refer to as Income funds) but also Covered Call Dividend ETFs which make their money with 1) Dividend Income and 2) Covered Call Option Premiums. But REITs can also give out ROC. I bet you didn't know that.
So you might be asking where do I get this information? Well 2 ways really. You can see the breakdown on your T3 Slip your broker gives you every year specifically. BOX 42.

Do you really think that just because a stock gives out a very high % of its income as ROC it will eventually go to 0? Of course not.
Let’s look at the stock chart of the last 5 years of the examples I showed you earlier like True North Commercial REIT, the Canoe EIT Income fund and ZWC.
Although the distributions from these funds are mostly ROC, the stock price of the funds seem to be doing just fine and following what the overall stock market is doing or what the stocks inside the ETF are doing. It doesn't look like the stock price is just deteriorating and going down and down to 0. It's clearly not the case.

Here is the main takeaway as i see it : As long as the fund can keep generating income, you're fine. That's the bottom line.
And since Dividend income, Covered Call option income, Rental income is pretty much infinite, we have nothing to worry about.
#ReturnOfCapital #investment #passiveincome #invest#tsx #canada #CanadianStocks #investingtips

Disclaimer:
Not a licensed investment advisor, videos are educational.