Disposition: Definition, How It Works in Investing, and Example
Definition
A disposition is the act of selling or otherwise transferring ownership of an asset. Common types of dispositions include selling securities on an exchange, donating assets to charity or a trust, transferring property or assignments, and selling real estate. In all cases the disposer gives up legal possession of the asset.
How dispositions work for individual investors
- The most common disposition is selling shares through a broker on a stock exchange.
- If the sale produces a profit, capital gains tax may apply based on holding period and tax rules.
- Alternative forms of disposition—donations, transfers, or assignments—are often used for tax planning or liability management (for example, gifting assets to family or donating appreciated securities to charity).
Tax considerations and simple example
- Selling an appreciated asset typically triggers capital gains tax on the gain (sale price minus cost basis).
- Donating appreciated assets can provide tax advantages: the donor may avoid recognizing the capital gain and may claim a deduction for the asset’s fair market value, subject to tax-law limits.
- Example: An investor who bought stock for $5,000 and whose value rises to $15,000 could choose to:
- Sell and report a $10,000 capital gain (potentially taxable), or
- Donate the $15,000 stock to an eligible charity, possibly avoiding capital gains tax and claiming a charitable deduction for the full market value (subject to deduction rules).
Business dispositions (divestitures) and reporting requirements
- Companies dispose of assets or entire business units through divestitures, spinoffs, split-offs, or sales.
- Securities regulators require specific reporting when a disposition meets significance thresholds. If a disposal is significant, affected financial statements or pro forma disclosures are typically required.
- Two common significance tests:
- Investment test: the disposed unit’s asset value as a percentage of total assets (often >10% is significant).
- Income test: the unit’s share of income from continuing operations before taxes, extraordinary items, and similar adjustments (often >10% is significant).
- In certain circumstances regulatory thresholds can be higher (e.g., up to 20%), and companies must follow prescribed accounting and disclosure rules.
The disposition effect (behavioral finance)
- The disposition effect describes a common investor bias: selling winners too soon while holding losers too long, usually driven by loss aversion and the desire to avoid realizing losses.
- Studies of investor behavior suggest that reversing this tendency—letting winners run and cutting losers promptly—often improves long-term returns.
Key takeaways
- A disposition is any act of disposing of an asset—selling, donating, transferring, or assigning ownership.
- Tax consequences vary by disposition type; donations of appreciated assets can offer favorable tax treatment compared with sales.
- Businesses must follow regulatory reporting rules for significant disposals, using tests based on asset value or income.
- The disposition effect is a behavioral trap that can hurt investment performance if not managed.