What Is a Disposition?
When we talk about disposition, it means selling or rather disposing of an asset or a security. Usually, a disposition is selling a stock investment in an open market like a Stock Exchange to earn.
However, disposition may also mean charity donations, endowments, real estate sales, or any other financial asset that is up for selling. It can also refer to transfers and assignments.
The meaning can be diverse and dynamic, but the bottom line will always give up or sell an asset or possession. People would often use donations, transfers, and assignments for beneficial tax treatment.
A disposition process scenario
In the world of trading, the term disposition of shares is popular. For example, a shareholder investor decides to exit an investment through a stock Exchange broker.
If it incurred a value increase after the sale, the investor should pay capital gains tax using the money from the sale of that investment. The Internal Revenue Service or the IRS set the basis of this payment.
When dispositions remove the tax liabilities of the disposer
When transferred or assigned to someone else, dispositions remove the disposer’s tax obligations and other liabilities. How? For example, an investor who purchased a stock initially worth $1,000 that increased to $11,000 gave it to a charity institution or another organization.
This investor is now free from taxes from that investment and can also include this $11,000 in tax deductions. Other situations that resolve a person from taxes through a disposition include transfers to family.
Significance test, income test, and dispositions
Businesses also dispose of their assets, and we call this divestiture. The process is possible through spinoffs, split-ups, and split-offs. There are regulations set by the Securities and Exchange Commission or SEC that businesses must follow when they report and do such dispositions.
A pro forma financial statement is a requirement if there are no company records of the disposition. It evaluates if disposition passes a significance test requirement.
What is the significance, and how is it determined? There are two ways to test the significance of an asset. One is through a significance test, and the other is the income test.
The significance test measures the value of the investment that the business is disposing of versus the total assets. It is a significant asset if it is greater than 10% compared to the total assets’ most recent fiscal year-end.
The income test is the measurement of continuing operations equity income prior taxes, extraordinary items, and the total effects of accounting principles changes if they are 10% or more in the business’s most recent fiscal year-end.
If this happens, then there will be a threshold increase of up to 20%.
Let’s talk about the disposition effect
A term called the disposition effect describes an investor’s tendency to sell winning stocks early when they could generate a high yield and hold on to losing stocks longer because they believe that these investments will somehow turn around and create profits.
In behavior economics, this says a lot about an investor’s propensity to sell a winning investment versus a losing investment with the concept of loss aversion.
