Cash liquidation distribution definition
/What is a Cash Liquidation Distribution?
A cash liquidation distribution is a distribution of funds back to the investors in a business when it is liquidated. This distribution represents a return of the residual value of a business to investors. The taxable status of this distribution is as follows:
The distribution is nontaxable up to the amount of the investor's basis in the stock. Basis is usually the price paid to acquire the stock.
The distribution is taxable for all amounts exceeding the investor's basis in the stock. This amount is reported as a capital gain for income tax reporting purposes. It may be classified as a long-term or short-term capital gain, depending on the duration of the investor's holding period for the stock.
If the total amount of the distribution is less than the investor's basis in the stock, then report a capital loss instead, but only after the business has cancelled the investor's shares (thereby signifying that no additional payments are forthcoming). Another characteristic of a cash liquidation distribution is that it may be paid in several installments.
The total amount of the dividend is reported to investors by the liquidating company on the Form 1099-DIV.
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Terms Similar to Cash Liquidation Distribution
A liquidating distribution is also known as a liquidating dividend.
Example of a Cash Liquidation Distribution
Rose Manufacturing, a small electronics manufacturer, has struggled financially due to declining sales and increasing competition. After exploring all options, the company's board decides to dissolve the business and liquidate its assets. To do so, it engages in the activities noted below.
Step 1: Asset Liquidation
Rose sells its assets, which include machinery, equipment, inventory, and a factory building. The proceeds from these sales are as follows:
Machinery and equipment: $500,000
Inventory: $200,000
Factory building: $800,000
Cash on hand and receivables: $100,000
Total cash available: $1,600,000
Step 2: Settling Liabilities
Before distributing any funds to investors, Rose must settle its outstanding liabilities, which are as follows:
Bank loan: $600,000
Accounts payable: $200,000
Employee wages and benefits: $100,000
Legal and liquidation costs: $50,000
Total liabilities: $950,000
After paying off all liabilities, the remaining cash is:
$1,600,000 from assets - $950,000 from liabilities = $650,000
Step 3: Distribution to Shareholders
Rose has issued a total of 100,000 common shares to its investors. Since no preferred shares or other obligations exist, the remaining $650,000 will be distributed among common shareholders as a cash liquidation distribution. The cash distribution per share is:
$650,000 ÷ 100,000 shares = $6.50 per share
For example, if an investor owns 5,000 shares of Rose, they will receive the following cash distribution:
5,000 shares × $6.50 per share = $32,500
The $6.50 per share represents a return of the residual value after all debts and obligations have been cleared. Since the original purchase price of shares might have been higher, investors could realize a loss if the distribution is less than their initial investment.
This example illustrates how a cash liquidation distribution works, ensuring that funds are first used to settle liabilities before returning the remaining value to investors based on their shareholding.