REITS in Taxable Brokerage Accounts: Good or Bad

[stewardinlife]

Hello al,

Looking for some advice here. I am a relatively new in the DGI landscape (have around 7K invested in DGI stocks since April of this year), and have 2 REITS so far: WPC and OHI. I have these in a brokerage account.

I am reading that REITs are best in a tax-deferred accounts (401K, etc); and that they are taxed heavily in a brokerage (taxed) account.

I am in the 25% tax bracket from my daily job.

Should I stop having REITS in my portfolio?

Like to hear your views and opinions.

Thanks.

[Kerim]

I think the threshold question is what flexibility you have. If you are able to hold the REITs you want in a tax-advantaged account, then you are just deciding between accounts. If your ONLY option is to hold them in your taxable account, then you are deciding whether to have them at all. I'm not clear from your post which we are talking about.

[stewardinlife]

(07-10-2015, 12:32 PM)Kerim Wrote: I think the threshold question is what flexibility you have. If you are able to hold the REITs you want in a tax-advantaged account, then you are just deciding between accounts. If your ONLY option is to hold them in your taxable account, then you are deciding whether to have them at all. I'm not clear from your post which we are talking about.

Kerim,

My option seems to be to have the REITS in a taxable (non-retirement) brokerage account at this point. And so, question is whether the reits are good to have at all ( as I understand they are getting hit with many taxes).

(I do have a Roth IRA where I can invest in a REIT fund, which has a hundreds of reits, but I am not too enthused about them).

Thanks.

[Kerim]

Ok, thanks.

If the choice is whether to hold REITs at all in your taxable account, since tax-deferred is not an option, then you need to compare it to alternative investment options, taking tax considerations into account. People prefer to have their REITs in the tax-deferred accounts because (generally) REIT distributions are taxed at your normal income rate, rather than at the lower rate that applies (generally) to dividends from non-REITs. This dynamic is exacerbated by the generally higher yields that REITs provide.

So to answer your question more directly, you need to decide how the REITs are going to fit into your portfolio. From a tax-adjusted income standpoint, you'll generally do better in shares of T than in a REIT paying 5.4 percent, simply because you'll lose more of the latter's income to taxes. But if you're comparing a REIT paying 5.4 percent to a stock paying 3.5 percent, you'll have to do some math based on your particular tax rate to see which way you come out better.

BUT, all that said, in my humble opinion, you should not be put off from holding REITs in a taxable account just because the tax treatment is not as favorable as for other dividends. Current income and tax treatment are usually not the end of the inquiry. For example, you may believe that some REITs are well-priced right now, giving you a better prospect of capital appreciation than other alternatives.

At bottom, if you believe that you want REITs to play a role in your well-constructed and well-diversified portfolio, and your only option is to hold them in a taxable account, then go right ahead. Consider the extra tax you pay on them as your "success tax" for putting together such a nice portfolio.

[stewardinlife]

(07-10-2015, 01:13 PM)Kerim Wrote: Ok, thanks.

If the choice is whether to hold REITs at all in your taxable account, since tax-deferred is not an option, then you need to compare it to alternative investment options, taking tax considerations into account. People prefer to have their REITs in the tax-deferred accounts because (generally) REIT distributions are taxed at your normal income rate, rather than at the lower rate that applies (generally) to dividends from non-REITs. This dynamic is exacerbated by the generally higher yields that REITs provide.

So to answer your question more directly, you need to decide how the REITs are going to fit into your portfolio. From a tax-adjusted income standpoint, you'll generally do better in shares of T than in a REIT paying 5.4 percent, simply because you'll lose more of the latter's income to taxes. But if you're comparing a REIT paying 5.4 percent to a stock paying 3.5 percent, you'll have to do some math based on your particular tax rate to see which way you come out better.

BUT, all that said, in my humble opinion, you should not be put off from holding REITs in a taxable account just because the tax treatment is not as favorable as for other dividends. Current income and tax treatment are usually not the end of the inquiry. For example, you may believe that some REITs are well-priced right now, giving you a better prospect of capital appreciation than other alternatives.

At bottom, if you believe that you want REITs to play a role in your well-constructed and well-diversified portfolio, and your only option is to hold them in a taxable account, then go right ahead. Consider the extra tax you pay on them as your "success tax" for putting together such a nice portfolio.

Kerim,

Thanks for taking the time to explain. When you say "shares of T" are you meaning AT&T stock, or a class of shares -- Sorry to ask this noob question.

Also, I just finished talking to Vanguard, where I have my Roth IRA -- They said I can open an Roth IRA brokerage acct. where I can buy any share and I thing they charge around $8 for a transaction. Would this be a better alternative?

Thanks again.

[rayray]

I'm a huge fan of Vanguard being with them for almost 20 years and counting. I have a regular brokerage account and my ROTH with Vanguard. What you do, as Vanguard explained is open up a sweep account within your ROTH, the sweep account, basically a MMA, is where you park your money until the monies is invested in a mutual fund or an individual stock of your choice. All of this is the same setup within your regular brokerage account. Personally, I realize that I can save money on commissions with other brokerages but I like having most of my money under one house such as Vanguard. They continually improve and with low cost well managed mutual funds available they're the credit union of brokerages, very hard to beat IMHO.

Kerim is right with everything he said about investing choices. I use to keep low yielding and non-dividend paying stocks in my brokerage account; however, that has been changing as time moves forward. I still don't have any REITS in my brokerage account, the only kind I would consider is a REIT directed more towards growth. At the moment, all of my REITS are in my ROTH and that's the plan for the foreseeable future. One has to keep an open mind to investing to what our options are at the moment we're investing.

[Dividend Watcher]

SIL,

I'm a little confused here. You have a Roth IRA but you can only invest in mutual funds? Is it in a fund family such as Vanguard or Fidelity? You can have any number of Roth (or conventional) IRAs in different institutions as long as you don't contribute more than the statutory limit in any calendar year. You can even spread your contributions between institutions.

Would it not make sense to open a Roth at a brokerage, as the Vanguard representative replied, and transfer your mutual funds that you do have into it using a custodian-to-custodian transfer? Most brokerages allow you to hold funds as well as individual securities. Maybe I'm confused.

Regardless, I think Kerim's thoughts were spot on ...

(07-10-2015, 01:13 PM)Kerim Wrote: People prefer to have their REITs in the tax-deferred accounts because (generally) REIT distributions are taxed at your normal income rate, rather than at the lower rate that applies (generally) to dividends from non-REITs. This dynamic is exacerbated by the generally higher yields that REITs provide.

The non-qualified vs. qualified (respectively) dividend frustration.

From Pub. 550 over at IRS.GOV:

Quote:Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive.

The maximum rate of tax on qualified dividends is:

• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
  
• 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%.
  
• 20% on any amount that otherwise would be taxed at a 39.6% rate.
  

To qualify for the maximum rate, all of the following requirements must be met.

1. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. (See Qualified foreign corporation , later.)
   
2. The dividends are not of the type listed later under Dividends that are not qualified dividends .
   
3. You meet the holding period (discussed next).
   

Holding period. You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date 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. When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it.

REITs are specifically mentioned as non-qualified since they do not pay corporate income taxes as long as they distribute 90% (I believe) of their net income to shareholders.

(07-10-2015, 01:13 PM)Kerim Wrote: BUT, all that said, in my humble opinion, you should not be put off from holding REITs in a taxable account just because the tax treatment is not as favorable as for other dividends. Current income and tax treatment are usually not the end of the inquiry. For example, you may believe that some REITs are well-priced right now, giving you a better prospect of capital appreciation than other alternatives.

I agree, don't let the "tax tail" wag the investment "dog". Just because REIT non-qualified dividends don't qualify for the favored tax treatment, the realized capital gains still are.

However, to see the damage, let's assume it's a REIT valued at US$100 with a 5% yield or $5.00/share. Using your marginal tax rate of 25%, for every share your own, you'll owe the government $1.25 dropping the amount you actually keep in your pocket to $3.75 or 3.75% after-tax yield. Still not a bad yield point.

T pays you $1.88/share in dividends but they are "qualified" dividends. At your marginal rate, you would get the 15% dividend tax rate and end up with $1.60/share net dividend. This would drop your yield from 5.4% to 4.6% after-tax yield at the current share price.

(07-10-2015, 05:16 PM)stewardinlife Wrote: Kerim,

Thanks for taking the time to explain. When you say "shares of T" are you meaning AT&T stock, or a class of shares -- Sorry to ask this noob question.

I believe Kerim was referring to AT&T (stick symbol: T). Their dividend yield is up there in REIT territory.

[stewardinlife]

(07-11-2015, 01:27 PM)rayray Wrote: I'm a huge fan of Vanguard being with them for almost 20 years and counting. I have a regular brokerage account and my ROTH with Vanguard. What you do, as Vanguard explained is open up a sweep account within your ROTH, the sweep account, basically a MMA, is where you park your money until the monies is invested in a mutual fund or an individual stock of your choice. All of this is the same setup within your regular brokerage account. Personally, I realize that I can save money on commissions with other brokerages but I like having most of my money under one house such as Vanguard. They continually improve and with low cost well managed mutual funds available they're the credit union of brokerages, very hard to beat IMHO.

Kerim is right with everything he said about investing choices. I use to keep low yielding and non-dividend paying stocks in my brokerage account; however, that has been changing as time moves forward. I still don't have any REITS in my brokerage account, the only kind I would consider is a REIT directed more towards growth. At the moment, all of my REITS are in my ROTH and that's the plan for the foreseeable future. One has to keep an open mind to investing to what our options are at the moment we're investing.

rayray, thanks for the feedback. So one option for me here is, to open the brokerage inside of my Roth in my Vanguard; And buy REITS (or ind. stocks) in that account. I do see that Vanguard charges $8 or $10 per trade, and that is the only slight negative point (as brokerages charge smaller, esp. tradeking, the one I have). Nevertheless, I do see your point in the overall benefits at Vanguard.

Thanks again.

---

(07-11-2015, 11:37 PM)Dividend Watcher Wrote: SIL,

I'm a little confused here. You have a Roth IRA but you can only invest in mutual funds? Is it in a fund family such as Vanguard or Fidelity? You can have any number of Roth (or conventional) IRAs in different institutions as long as you don't contribute more than the statutory limit in any calendar year. You can even spread your contributions between institutions.

Would it not make sense to open a Roth at a brokerage, as the Vanguard representative replied, and transfer your mutual funds that you do have into it using a custodian-to-custodian transfer? Most brokerages allow you to hold funds as well as individual securities. Maybe I'm confused.

Regardless, I think Kerim's thoughts were spot on ...

(07-10-2015, 01:13 PM)Kerim Wrote: People prefer to have their REITs in the tax-deferred accounts because (generally) REIT distributions are taxed at your normal income rate, rather than at the lower rate that applies (generally) to dividends from non-REITs. This dynamic is exacerbated by the generally higher yields that REITs provide.

The non-qualified vs. qualified (respectively) dividend frustration.

From Pub. 550 over at IRS.GOV:

Quote:Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive.

The maximum rate of tax on qualified dividends is:

• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
  
• 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%.
  
• 20% on any amount that otherwise would be taxed at a 39.6% rate.
  

To qualify for the maximum rate, all of the following requirements must be met.

1. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. (See Qualified foreign corporation , later.)
   
2. The dividends are not of the type listed later under Dividends that are not qualified dividends .
   
3. You meet the holding period (discussed next).
   

Holding period. You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date 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. When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it.

REITs are specifically mentioned as non-qualified since they do not pay corporate income taxes as long as they distribute 90% (I believe) of their net income to shareholders.

(07-10-2015, 01:13 PM)Kerim Wrote: BUT, all that said, in my humble opinion, you should not be put off from holding REITs in a taxable account just because the tax treatment is not as favorable as for other dividends. Current income and tax treatment are usually not the end of the inquiry. For example, you may believe that some REITs are well-priced right now, giving you a better prospect of capital appreciation than other alternatives.

I agree, don't let the "tax tail" wag the investment "dog". Just because REIT non-qualified dividends don't qualify for the favored tax treatment, the realized capital gains still are.

However, to see the damage, let's assume it's a REIT valued at US$100 with a 5% yield or $5.00/share. Using your marginal tax rate of 25%, for every share your own, you'll owe the government $1.25 dropping the amount you actually keep in your pocket to $3.75 or 3.75% after-tax yield. Still not a bad yield point.

T pays you $1.88/share in dividends but they are "qualified" dividends. At your marginal rate, you would get the 15% dividend tax rate and end up with $1.60/share net dividend. This would drop your yield from 5.4% to 4.6% after-tax yield at the current share price.

(07-10-2015, 05:16 PM)stewardinlife Wrote: Kerim,

Thanks for taking the time to explain. When you say "shares of T" are you meaning AT&T stock, or a class of shares -- Sorry to ask this noob question.

I believe Kerim was referring to AT&T (stick symbol: T). Their dividend yield is up there in REIT territory.

DW, Thank you for the in-depth explanation.

To answer your first question: Yes, in my current Vanguard Roth acct. they only would let me buy funds and not individual stocks. ANd that is the reason I asked them and found out that the only way to own ind. stocks is to open a roth brokerage acct. with them.

Thanks for mentioning the option of custodian transfer to my brokerage acct. from Vanguard, and also for the break down examples.

I am going think through this a bit and see the best option.

You guys are great I have to say for the advise and education!

---

Also, just another quick clarification requested: Are REITS the only type of stocks that have this type of tax structure, or anyothers -- like MLPs. etc.

I just want to make sure which vehicle I put them in, when I do purchase them

Thanks again.

[rayray]

One more thing about Vanguard, their fees are tiered. Basically, the more money you have the less they charge the client/shareholder.

See link below:

https://personal.vanguard.com/us/whatweo...ommissions


And you're right, there are cheaper brokerages available for someone starting out in the investment world. I'm a creature of habit and been with Vanguard before online trading was widely available and that's the way the ball bounced for me and it worked out well.

[stewardinlife]

(07-13-2015, 06:57 PM)rayray Wrote: One more thing about Vanguard, their fees are tiered. Basically, the more money you have the less they charge the client/shareholder.

See link below:

https://personal.vanguard.com/us/whatweo...ommissions


And you're right, there are cheaper brokerages available for someone starting out in the investment world. I'm a creature of habit and been with Vanguard before online trading was widely available and that's the way the ball bounced for me and it worked out well.

Thanks for the link.