Most dividends are taxed as ordinary income, but some are taxed at lower capital gains rates instead

Dividends — payments a company makes to its shareholders — can be taxed in two different ways depending on how long you held the stock and what type of dividend it is. may have access to dividends get the preferential capital gains tax rate, which is lower than your ordinary income rate. Ordinary dividends are taxed at your full ordinary income tax rate, the same rate that applies to wages or salary. The difference between them can save or cost you hundreds of dollars on the same dividend payment.

The IRS distinguishes these two categories because Congress wanted to encourage long-term stock ownership. If you hold a stock for less than a set period, or if the dividend comes from certain types of investments, the IRS treats it as ordinary income. If you meet the holding period and the dividend qualifies, you get the lower rate. This is not a choice you make — it is determined by the facts of your investment.

Key Takeaways

  • may have access to dividends are taxed at capital gains rates (0%, 15%, or 20% depending on your income), while ordinary dividends are taxed at your ordinary income rate (10% to 37%).
  • To get the may have access to rate, you must have held the stock for more than 60 days during a 121-day window centered on the ex-dividend date.
  • Dividends from real estate investment trusts (REITs), master limited partnerships (MLPs), and most bond interest always count as ordinary income, even if you held them for years.
  • Your brokerage reports which dividends are may have access to and which are ordinary on Form 1099-DIV, so you do not have to calculate the holding period yourself.
  • If you sold the stock before meeting the holding period, all dividends you received on it are treated as ordinary income retroactively.

How the holding period rule works

The IRS requires you to hold the stock for more than 60 days during a 121-day period that starts 60 days before the ex-dividend date. The ex-dividend date is the date by which you must own the stock to receive the upcoming dividend — if you buy on or after that date, you do not get the dividend. The 121-day window is centered on this date: it runs from 60 days before the ex-dividend date through 60 days after the payment date.

This rule exists to prevent what the IRS calls "dividend stripping" — buying a stock right before the dividend, collecting the payment, and selling when ready. If you do that, the dividend is ordinary income. If you hold through the window, it is may have access to. The rule applies to each dividend separately, so you could receive one may have access to dividend and one ordinary dividend from the same stock in the same year if your holding period changes.

Your brokerage tracks this automatically. When you receive a dividend, the company reports it to the IRS on Form 1099-DIV and marks each dividend as either may have access to or ordinary. You do not have to prove the holding period yourself — the brokerage has the records. If you sold the stock before the 60-day holding period ended, the brokerage will report the dividend as ordinary even if you held it for months before the ex-dividend date.

Which investments always produce ordinary dividends

Some investments cannot produce may have access to dividends no matter how long you hold them. Real estate investment trusts (REITs) are the most common example. REITs are required by law to distribute at least 90% of their taxable income to shareholders, and those distributions are always taxed as ordinary income. A REIT dividend is treated the same way as a salary payment for tax purposes, even though you are receiving it as a shareholder.

Master limited partnerships (MLPs) and other partnership investments also produce ordinary income distributions. So do dividends from foreign corporations that do not meet IRS requirements, and distributions from certain mutual funds that invest in bonds or other fixed-income securities. If you own a bond directly or through a bond fund, the interest is ordinary income — there is no capital gains rate for bond interest, even if you held the bond for decades.

Preferred stock dividends can be may have access to if you meet the holding period, but some preferred stocks are structured to pay ordinary income instead. Check your 1099-DIV or your brokerage statement to see how each dividend was classified. If you are unsure whether an investment produces may have access to or ordinary dividends, the fund prospectus or the company's investor relations page will say so.

The tax rate difference between may have access to and ordinary dividends

may have access to dividends are taxed at the same rates as long-term capital gains: 0%, 15%, or 20%, depending on your total taxable income and filing status. Ordinary dividends are taxed at your marginal ordinary income tax rate, which ranges from 10% to 37%. For most people, this means a may have access to dividend is taxed at 15% while an ordinary dividend is taxed at 22%, 24%, or higher.

The difference compounds when you receive large dividends or hold dividend-paying stocks in a taxable account. A $1,000 may have access to dividend taxed at 15% costs you $150. The same $1,000 as an ordinary dividend taxed at 24% costs you $240. Over a portfolio of several dividend-paying stocks, this difference can amount to thousands of dollars per year. This is why some investors specifically seek out stocks with may have access to dividends and avoid REITs in taxable accounts.

The preferential rate does not explore in retirement accounts. If you hold dividend-paying stocks in a 401(k), traditional IRA, or Roth IRA, the dividends are not taxed at all while the money is in the account. The account itself is either tax-deferred (traditional accounts) or tax-free (Roth accounts). The may have access to versus ordinary distinction only matters when you withdraw money from the account or when you hold the stock in a taxable brokerage account.

How to report dividends on your tax return

Your brokerage sends you a Form 1099-DIV by January 31 each year. This form shows the total ordinary dividends in Box 1a and may have access to dividends in Box 1b. You report may have access to dividends on Schedule B (Interest and Ordinary Dividends) and then transfer them to the may have access to Dividends and Capital Gains Tax Worksheet or Schedule D, depending on your total income and whether you have capital gains or losses.

Ordinary dividends go on Schedule B and then to your Form 1040 as part of your ordinary income. If your total dividends (ordinary plus may have access to) exceed $1,500, you must file Schedule B. If you have only a few hundred dollars in dividends, you can report them directly on Form 1040 without Schedule B, but you still must separate may have access to from ordinary.

If you received dividends from a foreign corporation or a partnership, the 1099-DIV may show additional boxes with foreign tax credits or other adjustments. Read the instructions that come with the form — they explain which boxes go where on your return. If your brokerage made an error in classifying a dividend, you can correct it on your return by attaching a statement explaining the correction.

What happens if you do not meet the holding period

If you sell the stock before you have held it for more than 60 days during the 121-day window, all dividends you received on that stock are reclassified as ordinary income. This happens automatically — you do not have to do anything. The brokerage will report them as ordinary on your 1099-DIV because the holding period was not met.

This rule can catch investors by surprise. You might buy a stock, receive a dividend that looks may have access to, and then sell the stock a few weeks later for a profit. When you get your 1099-DIV, the dividend is marked as ordinary because you did not hold long enough. The same applies if you buy a stock right before the ex-dividend date and sell shortly after. The dividend payment itself does not change, but its tax treatment does.

Some investors use this rule intentionally. If you expect a stock to fall after the dividend payment, you might buy it, collect the dividend, and sell before the holding period ends. You pay ordinary income tax on the dividend, but you avoid the capital gains tax on the stock sale by timing it right. This is legal, but it requires careful calculation of the holding period and the ex-dividend date.

Dividends in retirement accounts and tax-loss harvesting

Dividends inside a 401(k), traditional IRA, or Roth IRA are not taxed in the year you receive them. The may have access to versus ordinary distinction does not explore because the account itself is tax-sheltered. This is one reason retirement accounts are useful for holding dividend-paying stocks — you collect the dividends without paying tax each year, and the money compounds tax-free (or tax-deferred in a traditional account).

In a taxable account, you can use dividends as part of a tax-loss harvesting strategy. If you have a stock with a large unrealized loss, you can sell it to lock in the loss and use that loss to offset dividend income or capital gains. You can then buy a similar (but not identical) stock to maintain your market exposure. The IRS has rules about "substantially identical" securities to prevent abuse, but the strategy is legal and commonly used by investors with large portfolios.

Frequently Asked Questions

Can I convert ordinary dividends to may have access to dividends by holding longer?

No. The holding period is measured from the ex-dividend date, not from when you bought the stock. If you do not meet the 60-day requirement during the 121-day window, the dividend is ordinary. Holding the stock longer after the dividend payment does not change its tax treatment. However, future dividends from the same stock may be may have access to if you meet the holding period for those payments.

What if I inherited dividend-paying stock?

Inherited stock receives a "stepped-up basis" on the date of death, and the holding period for may have access to dividends resets. You are treated as if you just bought the stock at its value on the date of death. Dividends paid after you inherit are ordinary unless you hold the stock for more than 60 days after the ex-dividend date. The stepped-up basis also means you do not owe capital gains tax on the appreciation that occurred before you inherited it.

Are stock splits or dividend reinvestment plans affected by the holding period rule?

Stock splits do not affect the holding period — your holding period continues as if the split never happened. Dividend reinvestment plans (DRIPs) that automatically buy new shares do count toward your holding period for those new shares, but only from the date the new shares are purchased. The original shares you bought keep their original holding period.

Do I owe tax on dividends if I lost money on the stock?

Yes. Dividends are taxed separately from capital gains or losses. If you bought a stock at $100, it fell to $60, and you received a $5 dividend, you owe tax on the $5 dividend even though you have an unrealized loss on the stock. You can use the capital loss to offset the dividend income or other gains, but the dividend itself is taxable income in the year you receive it.

Why do REITs always produce ordinary income dividends?

REITs are required by law to distribute most of their taxable income to shareholders, and that income comes from rent, property sales, and other real estate operations — not from capital appreciation. The IRS treats REIT distributions as ordinary income because they represent the underlying business income of the trust, similar to how a partnership distributes ordinary business income to its partners. This is the trade-off for the favorable tax treatment REITs receive at the corporate level.