How to preserve the newline character (\n) when capture output of a command in a variable

output=$(head $file) keeps embedded newlines in the value of output, and trims all trailing newlines.

It's how you reference the variable that makes the difference.

Placing the variable reference within double quotes, for example:

echo "$output"

prints the embedded newlines, but not the trailing newlines, which were deleted by the command expansion $(...).

This works because the shell interprets only dollar sign, command expansion (back quotes and $(...)), and back slashes within double quotes; the shell does not interpret whitespace (including newlines) as field separators when inside double quotes.

It is a known flaw of "command expansion" $(...) or `...` that the last newline is trimmed.

If that is your case:

$ output="$(head -- "$file"; echo x)"     ### capture the text with an x added.
$ output="${output%?}"                    ### remove the last character (the x).

Will correct the value of output.

To also preserve the exit status:

output=$(head < "$file"; r=$?; echo /; exit "$r")
exit_status=$?
output=${output%/}

Note that using / is safer than x as there are some character sets used by some locales where the encoding of some characters end in the encoding of x (while the encoding of / would generally not be found in other characters as that would make path lookup problematic for instance).