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Income Stocks With A Trump Tax Bonus

By newadmin / Published on Monday, 29 Jan 2018 15:59 PM / No Comments / 8 views


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Real estate investment trusts are going to be surprisingly good to you at tax time.

Looking for stocks with fat dividends? Congress just delivered a bonanza. Two kinds of yield stocks are going to enjoy that 20% tax deduction awarded to “pass through” entities: real estate investment trusts and master limited partnerships.

Both Reits and MLPs present opportunities now for investors looking to get income from their taxable accounts. In this review we’ll look at ways to extract the most from Reits. A later essay will delve into energy-driven MLPs.

Real estate investment trusts own things like office buildings, strip malls and apartments. They collect rent, pay expenses and remit what’s left to their shareholders. They are like mutual funds except that their portfolios contain deeds instead of shares. Like mutual funds, they must distribute 90% of their taxable income.

What’s new:&nbsp; Beginning with returns filed in April 2019, shareholders will be able to trim 20% off the taxable part of their Reit dividends. It’s enough of a break to make many Reits a compelling purchase in a taxable account.

Why 20%? Congress (the Republicans in it, that is) decreed that the economy would be boosted by a lowering of business income taxes. Businesses organized as corporations get a rate cut; those organized as partnerships, which pass through income to their partners, get a comparable benefit in the form of a 20% exemption.

Reits came along for a ride with the partnerships. I’m not sure of the politics, but maybe we can credit hard-working lobbyists for Nareit, the National Association of Real Estate Investment Trusts.

What do you get out of this? Maybe you own shares of Camden Property Trust (CPT), a landlord with 53,400 apartments scattered across the sunnier parts of the country. Last year Camden paid a $3 dividend. Of that, $2.38 was ordinary income, taxed at high rates. The other 62 cents was from long-term capital gain, taxed at low rates.

Under the new law, the same sort of profits would generate $1.90 of taxable ordinary income, 62 cents of long gain, and 48 cents of untaxed cash. This is not a bad deal. If you’re in the 24% bracket (adjusted gross under $349,000 on a joint return), you’d owe 54 cents of federal tax on $3 of income, for a rate of 18%. That’s not much more than the 15% rate you’d owe on an Exxon Mobil dividend. (Both dividends are also potentially subject to the 3.8% Obamacare surtax.)

It used to be a commonplace among financial planners that Reits should go only in a tax-deferred account, since they pay high dividends taxed at ordinary rates. It’s time to give that blanket rule a rest. Many Reits are taxed lightly and do fine in taxable accounts. Save space in your IRA for assets that have even more exposure to the tax collector, like corporate bonds.

There’s more than the new 20% gimmie to lighten the tax burden on a Reit. Here are four other sources of protection.

Appreciation. If earnings grow at the Reit, its share price will grow. As with any growth stock, you don’t owe income tax on appreciation unless and until you sell, and when you do sell (after holding for at least a year) the gain is federally taxed at the favorable rate you pay on dividends. For most investors, this rate is 15% or 20%.

Equinix (EQIX), a Reit that owns a collection of data centers spanning the globe, has delivered most of its return in the form of appreciation. The dividend yield is a meager 1.8%, but the shares are up 37-fold from when they were first offered to the public 18 years ago.

Cap gain distributions. If the Reit sells off some of its real estate at a profit, the gain will pass through to shareholders, all the while retaining its tax attributes. Long-term gains are, for the most part, taxed at the favorable dividend rate.

In 2016 Equity Residential (EQR), the largest apartment Reit, sold buildings with 30,000 units. It dished out $13.02 a share that year in distributions, $12.29 of the total representing capital gain.

Capital gains come and go at companies that manage buildings. But they are a steady feature of arboreal Reits. Revenue from timber cutting is treated by the tax code as revenue from the sale of a capital asset, and hence entitled to a low tax rate.

Rayonier (RYN), which watches the trees grow on 2.7 million acres, paid out $1 a share last year, all of it long-term gain. The $1.53 dividend from forester Potlatch Corp. (PCH) was also 100% long gain.

For the non-timber Reits there’s a little catch here, relating to depreciation. The portion of the gain that comes from accelerated depreciation on buildings is taxed, under Section 1250 of the tax code, at a maximum rate of 25%. Roughly a fourth of the Equity Residential gain payout in 2016 got that treatment. You’re slightly worse off with this kind of dividend than with the usual long-term gain, but still better off than with ordinary income.

Qualified dividends. Dividends from corporations that pay corporate income tax get the favorable 15%/20% rate. If the Reit picks up dividend income of this sort (for example, from a taxable subsidiary), then that income passes through to Reit shareholders, retaining its favorable status. The $7 dividend from Equinix in 2016 included $2.07 of this nice kind of money.

Return-of-capital dividends. Say you buy a share for $100 and the company earns $3 a share. But it sends you a $4 dividend. That extra dollar is, in the eyes of the IRS, a return of your principal, and not immediately taxable.

You must now reduce your tax cost for the share to $99. That will boost your gain if and when you sell, but the sale may occur a long time from now or never. Remember that you escape capital gain tax on shares left in your estate or donated to charity.

Many Reits are in the habit of dishing out profits higher than their taxable income. They can do that because taxable income is computed after deducting paper depreciation charges, while the cash profit is more closely aligned with income before depreciation. A Reit can sustainably distribute this amount: net income plus depreciation minus maintenance-level capital expenditures.

Consider Kimco Realty (KIM), which owns 500 or so strip malls. In 2016 it earned $386 million. But it had additional cash to throw around because its depreciation was $212 million higher than&nbsp;what it spent to spruce up the malls. Kimco’s 2017 financials aren’t out yet but we do know that only 64 cents of its $1.08 dividend last year was taxable. The other 44 cents was a return of capital.

A similar breakdown this year, with the 20% Trump freebie in effect, would put upper-middle-income Kimco payees in an 11.2% federal bracket. That’s less than they pay on their Exxon Mobil dividends. The Kimco number does not include the effect of your lowered cost basis on a future sale of shares, but this effect is very small for many investors. Those with legacy or philanthropy in mind don’t have to worry about it.

We must now examine a small cloud in this bright tax picture. In four years a tightening of the rules on how much interest companies may deduct will kick in, says a tax expert at Nareit. To avoid its impact, some Reits may have to stretch out depreciation a bit on their tax returns. That will move some of your dividend from the return-of-capital column to the taxable column. Alternatively, a Reit can finesse the interest cap by replacing some of its borrowed capital with preferred shares. I expect that the interest limitation will do only small damage to Reit shareholders.

To sum up: The new law gives a tax holiday to 20% of your ordinary income dividends, and there are four other ways that Reit profits are partly protected. The table displays 20 companies with significant payouts from favored sources in 2016. You can find the raw 2016 numbers, and the 2017 numbers just now trickling in, on this Nareit page.

So far Wall Street remains unamused by the&nbsp;20% deduction for Reits; the sector has barely budged since Congress cut taxes. The damper, says Jay Hatfield, who runs the InfraCap Reit Preferred ETF (PFFR), seems to be a fear of rising inflation and rising interest rates.

I think that fear is irrational for an investor in the common shares of an equity Reit, the kind discussed here. (Mortgage Reits are a different animal.) The current price weakness makes Reits an attractive place to put money on which you seek both an income and inflation protection.

Timber Reits like Rayonier and Potlatch deliver yields near 3% along with commodity exposure. Camden and Equity Residential mix steady 3%-plus income from apartment rentals with occasional capital gain extras from property sales.

You can get faster growth, albeit at a much higher multiple of earnings, in the data centers at Equinix. (I am inclined to overlook the abrupt departure last week of its chief executive.) But balance out this risky play with a value stock.

Kimco shares, at $16, are half the price they were a few years ago. Investors are fearful that Amazon will destroy the retail business. Sure enough, Kimco has lost some K Mart and Payless tenants. But it’s adding leases to Domino’s, AT&amp;T and AutoZone. Its space is 96% occupied. The stock yields 7%.

“>

Shutterstock

Real estate investment trusts are going to be surprisingly good to you at tax time.

Looking for stocks with fat dividends? Congress just delivered a bonanza. Two kinds of yield stocks are going to enjoy that 20% tax deduction awarded to “pass through” entities: real estate investment trusts and master limited partnerships.

Both Reits and MLPs present opportunities now for investors looking to get income from their taxable accounts. In this review we’ll look at ways to extract the most from Reits. A later essay will delve into energy-driven MLPs.

Real estate investment trusts own things like office buildings, strip malls and apartments. They collect rent, pay expenses and remit what’s left to their shareholders. They are like mutual funds except that their portfolios contain deeds instead of shares. Like mutual funds, they must distribute 90% of their taxable income.

What’s new:  Beginning with returns filed in April 2019, shareholders will be able to trim 20% off the taxable part of their Reit dividends. It’s enough of a break to make many Reits a compelling purchase in a taxable account.

Why 20%? Congress (the Republicans in it, that is) decreed that the economy would be boosted by a lowering of business income taxes. Businesses organized as corporations get a rate cut; those organized as partnerships, which pass through income to their partners, get a comparable benefit in the form of a 20% exemption.

Reits came along for a ride with the partnerships. I’m not sure of the politics, but maybe we can credit hard-working lobbyists for Nareit, the National Association of Real Estate Investment Trusts.

What do you get out of this? Maybe you own shares of Camden Property Trust (CPT), a landlord with 53,400 apartments scattered across the sunnier parts of the country. Last year Camden paid a $3 dividend. Of that, $2.38 was ordinary income, taxed at high rates. The other 62 cents was from long-term capital gain, taxed at low rates.

Under the new law, the same sort of profits would generate $1.90 of taxable ordinary income, 62 cents of long gain, and 48 cents of untaxed cash. This is not a bad deal. If you’re in the 24% bracket (adjusted gross under $349,000 on a joint return), you’d owe 54 cents of federal tax on $3 of income, for a rate of 18%. That’s not much more than the 15% rate you’d owe on an Exxon Mobil dividend. (Both dividends are also potentially subject to the 3.8% Obamacare surtax.)

It used to be a commonplace among financial planners that Reits should go only in a tax-deferred account, since they pay high dividends taxed at ordinary rates. It’s time to give that blanket rule a rest. Many Reits are taxed lightly and do fine in taxable accounts. Save space in your IRA for assets that have even more exposure to the tax collector, like corporate bonds.

There’s more than the new 20% gimmie to lighten the tax burden on a Reit. Here are four other sources of protection.

Appreciation. If earnings grow at the Reit, its share price will grow. As with any growth stock, you don’t owe income tax on appreciation unless and until you sell, and when you do sell (after holding for at least a year) the gain is federally taxed at the favorable rate you pay on dividends. For most investors, this rate is 15% or 20%.

Equinix (EQIX), a Reit that owns a collection of data centers spanning the globe, has delivered most of its return in the form of appreciation. The dividend yield is a meager 1.8%, but the shares are up 37-fold from when they were first offered to the public 18 years ago.

Cap gain distributions. If the Reit sells off some of its real estate at a profit, the gain will pass through to shareholders, all the while retaining its tax attributes. Long-term gains are, for the most part, taxed at the favorable dividend rate.

In 2016 Equity Residential (EQR), the largest apartment Reit, sold buildings with 30,000 units. It dished out $13.02 a share that year in distributions, $12.29 of the total representing capital gain.

Capital gains come and go at companies that manage buildings. But they are a steady feature of arboreal Reits. Revenue from timber cutting is treated by the tax code as revenue from the sale of a capital asset, and hence entitled to a low tax rate.

Rayonier (RYN), which watches the trees grow on 2.7 million acres, paid out $1 a share last year, all of it long-term gain. The $1.53 dividend from forester Potlatch Corp. (PCH) was also 100% long gain.

For the non-timber Reits there’s a little catch here, relating to depreciation. The portion of the gain that comes from accelerated depreciation on buildings is taxed, under Section 1250 of the tax code, at a maximum rate of 25%. Roughly a fourth of the Equity Residential gain payout in 2016 got that treatment. You’re slightly worse off with this kind of dividend than with the usual long-term gain, but still better off than with ordinary income.

Qualified dividends. Dividends from corporations that pay corporate income tax get the favorable 15%/20% rate. If the Reit picks up dividend income of this sort (for example, from a taxable subsidiary), then that income passes through to Reit shareholders, retaining its favorable status. The $7 dividend from Equinix in 2016 included $2.07 of this nice kind of money.

Return-of-capital dividends. Say you buy a share for $100 and the company earns $3 a share. But it sends you a $4 dividend. That extra dollar is, in the eyes of the IRS, a return of your principal, and not immediately taxable.

You must now reduce your tax cost for the share to $99. That will boost your gain if and when you sell, but the sale may occur a long time from now or never. Remember that you escape capital gain tax on shares left in your estate or donated to charity.

Many Reits are in the habit of dishing out profits higher than their taxable income. They can do that because taxable income is computed after deducting paper depreciation charges, while the cash profit is more closely aligned with income before depreciation. A Reit can sustainably distribute this amount: net income plus depreciation minus maintenance-level capital expenditures.

Consider Kimco Realty (KIM), which owns 500 or so strip malls. In 2016 it earned $386 million. But it had additional cash to throw around because its depreciation was $212 million higher than what it spent to spruce up the malls. Kimco’s 2017 financials aren’t out yet but we do know that only 64 cents of its $1.08 dividend last year was taxable. The other 44 cents was a return of capital.

A similar breakdown this year, with the 20% Trump freebie in effect, would put upper-middle-income Kimco payees in an 11.2% federal bracket. That’s less than they pay on their Exxon Mobil dividends. The Kimco number does not include the effect of your lowered cost basis on a future sale of shares, but this effect is very small for many investors. Those with legacy or philanthropy in mind don’t have to worry about it.

We must now examine a small cloud in this bright tax picture. In four years a tightening of the rules on how much interest companies may deduct will kick in, says a tax expert at Nareit. To avoid its impact, some Reits may have to stretch out depreciation a bit on their tax returns. That will move some of your dividend from the return-of-capital column to the taxable column. Alternatively, a Reit can finesse the interest cap by replacing some of its borrowed capital with preferred shares. I expect that the interest limitation will do only small damage to Reit shareholders.

To sum up: The new law gives a tax holiday to 20% of your ordinary income dividends, and there are four other ways that Reit profits are partly protected. The table displays 20 companies with significant payouts from favored sources in 2016. You can find the raw 2016 numbers, and the 2017 numbers just now trickling in, on this Nareit page.

So far Wall Street remains unamused by the 20% deduction for Reits; the sector has barely budged since Congress cut taxes. The damper, says Jay Hatfield, who runs the InfraCap Reit Preferred ETF (PFFR), seems to be a fear of rising inflation and rising interest rates.

I think that fear is irrational for an investor in the common shares of an equity Reit, the kind discussed here. (Mortgage Reits are a different animal.) The current price weakness makes Reits an attractive place to put money on which you seek both an income and inflation protection.

Timber Reits like Rayonier and Potlatch deliver yields near 3% along with commodity exposure. Camden and Equity Residential mix steady 3%-plus income from apartment rentals with occasional capital gain extras from property sales.

You can get faster growth, albeit at a much higher multiple of earnings, in the data centers at Equinix. (I am inclined to overlook the abrupt departure last week of its chief executive.) But balance out this risky play with a value stock.

Kimco shares, at $16, are half the price they were a few years ago. Investors are fearful that Amazon will destroy the retail business. Sure enough, Kimco has lost some K Mart and Payless tenants. But it’s adding leases to Domino’s, AT&T and AutoZone. Its space is 96% occupied. The stock yields 7%.

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