What's the holding period to receive qualified dividend treatment

To receive qualified dividend treatment-which allows dividends to be taxed at long-term capital gains rates (0%, 15%, or 20%) rather than higher ordinary income rates-you must meet specific holding period requirements defined in IRC § 1(h)(11).

This rule applies to individual taxpayers and requires that the stock be held "at risk" for a minimum duration surrounding the ex-dividend date.

Core Explanation

The holding period requirements differ depending on whether the underlying security is common stock or preferred stock.

1. Common Stock Holding Period

For most dividends (including common stock and preferred stock dividends attributable to a period of less than 367 days), you must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

• The 121-Day Window: The window opens 60 days before the ex-dividend date and closes 60 days after the ex-dividend date.
• Minimum Hold: You must hold the shares for at least 61 days within this specific window.
• Ex-Dividend Date: This is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment.

2. Preferred Stock Holding Period

A longer holding period applies to dividends on preferred stock if the dividends are attributable to a period or periods aggregating in excess of 366 days (e.g., accumulated dividends).

• Requirement: You must hold the stock for more than 90 days during the 181-day period that begins 90 days before the ex-dividend date.
• Note: If the preferred stock dividend covers a period of less than 367 days, the standard "common stock" rule (more than 60 days) applies.

3. Calculating the Days

Tax practitioners must calculate the holding period precisely. The "trade date" (not settlement date) is generally used for acquisition and disposition.

• Day of Acquisition: Do not count the day you acquired the stock.
• Day of Disposition: Do count the day you sold or disposed of the stock.
• Result: To meet the "more than 60 days" requirement, there must be at least 61 days between the acquisition trade date and the sale trade date (assuming no hedging), provided those days fall within the 121-day window.

4. Suspension of Holding Period (Tolling)

The holding period clock stops (is "tolled") for any day on which your risk of loss is substantially diminished. You cannot count days during which you:

• Have an option to sell (put option), are under a contractual obligation to sell (short sale), or have made (and not closed) a short sale of substantially identical stock or securities.
• Have granted an option to buy substantially identical stock or securities (call option), unless it is a "qualified covered call."
• Hold one or more other positions in substantially similar or related property (diminished risk of loss).

Audit and Practitioner Considerations

The IRS routinely verifies dividend treatment via Form 1099-DIV, but automated matching often misses complex disqualifications.

1. Hedged Positions (Straddles):

   • Challenge: Taxpayers with "covered calls" that are deep-in-the-money or do not meet "qualified covered call" rules may inadvertently toll their holding period, disqualifying the dividend.
   • Risk: Writing a call option on a dividend-paying stock can reset or suspend the holding period calculation.

2. Payments in Lieu of Dividends:

   • Disqualification: If shares are lent out (e.g., in a margin account) to short sellers over the ex-dividend date, the taxpayer receives a "substitute payment in lieu of dividends" rather than an actual dividend.
   • Tax Impact: These payments are taxed as ordinary income, not qualified dividends. Brokerage statements sometimes label these clearly, but not always.

3. Foreign Corporations:

   • Assumption Check: Not all foreign dividends are qualified. The foreign corporation must be incorporated in a U.S. possession, eligible for benefits under a comprehensive U.S. income tax treaty, or the stock must be readily tradable on an established U.S. securities market.
   • PFIC Risk: Dividends from a Passive Foreign Investment Company (PFIC) are never qualified dividends.

4. Mutual Fund Distributions:

   • Flow-Through: For a mutual fund dividend to be qualified, the fund must have held the underlying stock for the required period, and the taxpayer must have held the mutual fund shares for the required period (same 61-day rule applies to the fund shares).

Summary

• Common Stock: Hold >60 days during the 121-day window beginning 60 days before ex-dividend.
• Preferred Stock: Hold >90 days during the 181-day window beginning 90 days before ex-dividend (if >366 days of accrued dividends).
• Counting: Exclude acquisition day; include disposition day.
• Risk: Holding period stops if risk of loss is diminished (hedging/options).
• Tax Rate: Qualified dividends are taxed at 0%, 15%, or 20% (plus 3.8% NIIT if applicable); non-qualified are taxed at ordinary income rates.

Suggested Next Steps

• Review Form 1099-DIV: Check Box 1b specifically. If Box 1b is empty or lower than Box 1a, the broker has determined some dividends did not meet the criteria.
• Analyze Trade Confirmations: For positions opened/closed near the ex-dividend date, manually calculate the days held using the "exclude buy date / include sell date" method.
• Check Margin Accounts: If you hold dividend-paying stocks in a margin account, verify with your broker that your shares were not lent out over the ex-dividend date.