No. of Recommendations: 2
I don't have any bond allocation, but I do have the more-or-less equivalent income allocation in the form of income CEFs. Turns out the allocation is 15%, a bit higher than intended. The average distribution yield is about 8%.
Most of them use techniques with options, etc. to minimize taxes, the hint is generally that part of the CEF name is "Tax-Managed". They arrange things such that a large part of the distribution is legally considered ROC (return of capital). Many of them do "managed distribution" therefore the NAV & price swing up and down while the payout stays constant.
ROC is not taxed, so this can be a big advantage. This advantage is lost in an IRA or Roth account.
I have been accumulating these over several years, without paying attention to whether the purchase was in a taxable or tax-advantaged account. Well. Turns out that almost half of these holdings sit in a tax-advantaged account. So now I need to move these holdings to a taxable account and replace them with stock holdings .
No. of Recommendations: 6
ROC is not taxed
Well, sort of, but not really.
It is true that if a distribution is classified as Return of Capital, it’s not even reportable. But what does happen, is that it decreases your basis in the stock. So if you bought $1,000 worth of XYZ and received a RoC payment of $150, then your basis in XYZ is now $850. So if you sell XYZ for $1,500, you have a $650 gain, not $500, and of course you could be taxed on that extra $150 (or not, depending on way too many personal circumstances to go into here). But regardless of whether you end up paying tax on it or not, it’s definitely reportable.
So really what RoC does is convert what would be reportable income this year, into reportable income in the year you sell. Also, the income is converted from some sort of dividend into some sort of capital gain. Whether either of those is good or bad depends, again, on lots of circumstances.
One wrinkle—one might wonder what happens if you receive 7 $150 RoC payments from XYZ? That’s a total of $1,050 in RoC payments, and the basis can’t go below zero, so the last $50 (and any subsequent RoC payments) are classified as long-term capital gains, which *are* reportable and potentially taxable.
Of course that all applies just to taxable accounts, but it’s not true that any RoC advantage is “lost”, as the advantage (if there is one, it may turn out to be a disadvantage), isn’t nearly as big as “not taxed”.
Brian
No. of Recommendations: 6
I think the lesson here is that you need to thoroughly understand what you're investing in -- including the income tax ramifications.
Over 30 years ago, I used to invest in Master Limited Partnerships (MLPs) as a way to reduce current year taxable income. I would have done just as well buying BRK and avoiding the more cumbersome tax reporting requirements (i.e., IRS Form K-1) of the MLP.
intercst
