REITs in taxable

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RedJunglefowl
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REITs in taxable

Post by RedJunglefowl »

For those who hold REITs by investing in a REIT index fund (so beyond what exists in total stock market or something), would you still do it if you had to hold your REIT allocation solely in a taxable account?
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Re: REITs in taxable

Post by White Coat Investor »

If you're in the distribution phase and spending the distributions, sure, why not? If in the accumulation phase? I probably wouldn't. But lots of people are foolishly filling up their tax-advantaged accounts with bonds forcing them to make decisions like this one. If you'd just put the bonds where they belong (in taxable) you might have room for the REITs in the tax-advantaged accounts.
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Re: REITs in taxable

Post by LH »

In accumulation, I would not hold REIT in taxable.

Vanguard variable annuity would be a consideration.

Have to look carefully at the numbers, costs, er, tax considerations, also the asset protection as a minor benefit.

If you can't shelter, reits become dicey.

.if reits yield 4 percent, at 25 percent tax rate, that's 1 percent tax cost a year, on top of expense ratio cost.(this is a bit of simplification)
Last edited by LH on Wed Feb 19, 2014 5:58 am, edited 2 times in total.
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Re: REITs in taxable

Post by Call_Me_Op »

EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not? If in the accumulation phase? I probably wouldn't. But lots of people are foolishly filling up their tax-advantaged accounts with bonds forcing them to make decisions like this one. If you'd just put the bonds where they belong (in taxable) you might have room for the REITs in the tax-advantaged accounts.
Hi EmergDoc,

I assume that you hold this position because bond returns are currently quite low and projected to be so for some time. Is this an accurate characterization?
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Re: REITs in taxable

Post by pkcrafter »

Yes, Doc, a little more explanation needed.

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Re: REITs in taxable

Post by beyou »

pkcrafter wrote:Yes, Doc, a little more explanation needed.

Paul
http://whitecoatinvestor.com/asset-loca ... n-taxable/

Reading this, argument is that higher return assets in taxable can expand your tax advantaged space,
and that there is a rebalancing advantage. Personally I have always found this to be an intuitive way
to go about asset location and have invested this way for years.

I put REIT and taxable bonds in my 401k, for ease of rebalancing back and forth.
I put Total Stock/Total Int plus munis in my taxable space, also for ease of rebalancing.
I would not go so far as to put all my stocks in tax advantaged, but I will put less tax efficient,
and more volatile equity holdings into tax advantaged accounts to maximize the benefit of rebalancing,
and retain some of the tax advantages of indices in taxable.

Would I put REIT in taxable, NO I WOULD NOT. The total return of REIT is comparable
to other equity sectors, but not after you figure in the cost of taxes. Just buy total stock and total int
if you need stocks in your taxable space for rebalancing or due to total size of taxable being much larger
than your tax advantaged.
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Re: REITs in taxable

Post by slbnoob »

From EmergDoc's post, viewing a 401K as a 0.75 * Roth (since I'm in the 25% tax bracket) was an eye opener. I never thought of it that way. I will have to revisit the asset allocation for my specific situation again when I plan to increase my bond buying next year in my 401K.
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Re: REITs in taxable

Post by abuss368 »

REITs in taxable does not appear to be a popular strategy!
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Re: REITs in taxable

Post by manwithnoname »

RedJunglefowl wrote:For those who hold REITs by investing in a REIT index fund (so beyond what exists in total stock market or something), would you still do it if you had to hold your REIT allocation solely in a taxable account?
I hold VNQ in a taxable account where I have a 10k capital gain (40%). If I sell I will have 0 cap gains tax on the 10k. If I had VNQ in my IRA I would have a tax of at least 15% on the entire investment.

Also about 1/3 of the current VNQ 4.0% dividend is a return of capital or capital gain which will be taxed as ordinary income if it was distributed in an IRA. I am willing to pay a tax of 15% (much less after deduction and exemptions are subtracted) on the 2.74% dividend in return for 0% tax on my capital gain.

When the price become attractive I will add to VNQ.

Now why is it better to hold VNQ in an IRA?
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Re: REITs in taxable

Post by House Blend »

blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.
http://whitecoatinvestor.com/asset-loca ... n-taxable/
I'm not trying to dissuade people from using munis in taxable, but the calculation in EmergDoc's blog is a a poor way of making the case for it.

In his example, you have stocks returning 8%/year, and bonds returning 2.16% (tax exempt) or 2.69% (taxable). Great. But if stocks are going to outperform like that, it means that when comparing allocation decisions, any choice that takes significantly more equity risk is going to trounce another that takes less.

And in the two scenarios, you end with
A: $220K Bonds in Roth, $930K Stocks in taxable (less $97K in LTCG tax)
B: $190K Bonds in taxable, $1000K Stocks in Roth

Adjusting for the hidden capital gains in the stocks in A, it's pretty clear that B took significantly more equity risk than A, so we are not surprised to see B "win".
EmergDoc wrote:The value of a 401K (AKA tax-deferred) account is a little more complicated. First, you recognize that the money in a 401K is only partly yours. Part of it is the governments. If your marginal tax rate at contribution is 33%, only 2/3 of the 401K is yours.
No, that's completely wrong. The part that is yours is a function of your marginal rate at withdrawal. Not always easy to know without a crystal ball. And more than one rate may apply, if your RMDs span multiple brackets or phase-outs.
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Re: REITs in taxable

Post by Mrxyz »

House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.
http://whitecoatinvestor.com/asset-loca ... n-taxable/
I'm not trying to dissuade people from using munis in taxable, but the calculation in EmergDoc's blog is a a poor way of making the case for it.

In his example, you have stocks returning 8%/year, and bonds returning 2.16% (tax exempt) or 2.69% (taxable). Great. But if stocks are going to outperform like that, it means that when comparing allocation decisions, any choice that takes significantly more equity risk is going to trounce another that takes less.

And in the two scenarios, you end with
A: $220K Bonds in Roth, $930K Stocks in taxable (less $97K in LTCG tax)
B: $190K Bonds in taxable, $1000K Stocks in Roth

Adjusting for the hidden capital gains in the stocks in A, it's pretty clear that B took significantly more equity risk than A, so we are not surprised to see B "win".
EmergDoc wrote:The value of a 401K (AKA tax-deferred) account is a little more complicated. First, you recognize that the money in a 401K is only partly yours. Part of it is the governments. If your marginal tax rate at contribution is 33%, only 2/3 of the 401K is yours.
No, that's completely wrong. The part that is yours is a function of your marginal rate at withdrawal. Not always easy to know without a crystal ball. And more than one rate may apply, if your RMDs span multiple brackets or phase-outs.
I am/was similarly confused and had posted a question on bonds in taxable with just a few responses - perhaps most already know this fact and are already placing bonds in taxable??
http://www.bogleheads.org/forum/viewtop ... 2&t=132847

I wonder if House Blend can explain a little more about
Adjusting for the hidden capital gains in the stocks in A, it's pretty clear that B took significantly more equity risk than A, so we are not surprised to see B "win".
Do you mean Option A has more taxes and thus does poorer? And why does Option B take more risks if B has same $ amount of stocks?

Thanks for your teaching!
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Re: REITs in taxable

Post by House Blend »

Mrxyz wrote:I wonder if House Blend can explain a little more about
Adjusting for the hidden capital gains in the stocks in A, it's pretty clear that B took significantly more equity risk than A, so we are not surprised to see B "win".
Do you mean Option A has more taxes and thus does poorer? And why does Option B take more risks if B has same $ amount of stocks?
The dollars that put food on the table are after tax dollars, so when comparing accounts with differing tax treatments, you need to compare after tax values.

In a large taxable account with capital gains, it can be tricky to do this, because you typically aren't going to spend the account all at once, and using techniques like Specific ID and TLH there are ways to postpone realizing gains (possibly to infinity, if the account is inherited).

Nevertheless, I do think the cap gains assumptions in the EmergDoc blog were reasonable: his Scenario A led to a taxable stock account worth $930,873, with $647,696 in (unrealized) capital gains. He then computed an equivalent after tax value by discounting the capital gains by 15% LTCG tax, about $97K.

And if you hold munis in taxable long term, the expectation is that all of the return is in dividends; the expected capital gain/loss is 0.

I don't really have a quibble with that, except to say that tax management techniques could make the after-tax value of the stock account higher.

So in EmergDoc's reckoning (using my roundoff errors)
A has an after-tax value of $222K + $931K - $97K = $1056K (79% stock)
B has an after-tax value of $1006K + $190K = $1196K (84% stock).
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Re: REITs in taxable

Post by White Coat Investor »

House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.
http://whitecoatinvestor.com/asset-loca ... n-taxable/
I'm not trying to dissuade people from using munis in taxable, but the calculation in EmergDoc's blog is a a poor way of making the case for it.

In his example, you have stocks returning 8%/year, and bonds returning 2.16% (tax exempt) or 2.69% (taxable). Great. But if stocks are going to outperform like that, it means that when comparing allocation decisions, any choice that takes significantly more equity risk is going to trounce another that takes less.

And in the two scenarios, you end with
A: $220K Bonds in Roth, $930K Stocks in taxable (less $97K in LTCG tax)
B: $190K Bonds in taxable, $1000K Stocks in Roth

Adjusting for the hidden capital gains in the stocks in A, it's pretty clear that B took significantly more equity risk than A, so we are not surprised to see B "win".
EmergDoc wrote:The value of a 401K (AKA tax-deferred) account is a little more complicated. First, you recognize that the money in a 401K is only partly yours. Part of it is the governments. If your marginal tax rate at contribution is 33%, only 2/3 of the 401K is yours.
No, that's completely wrong. The part that is yours is a function of your marginal rate at withdrawal. Not always easy to know without a crystal ball. And more than one rate may apply, if your RMDs span multiple brackets or phase-outs.
I'm not sure "completely wrong" is an accurate way of characterizing the argument. There are two accurate ways to look at it.

1) You own a percentage of your tax-deferred account equivalent to 1- your marginal rate at contribution AND you get a "arbitrage" upon withdrawal which is the difference between your marginal rate at contribution and your effective rate at withdrawal or

2) You own a percentage of your tax-deferred account equivalent to 1-your effective rate at withdrawal.

Both are accurate, neither is "completely wrong" and both are useful in some ways, and not useful in others.
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Re: REITs in taxable

Post by White Coat Investor »

Call_Me_Op wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not? If in the accumulation phase? I probably wouldn't. But lots of people are foolishly filling up their tax-advantaged accounts with bonds forcing them to make decisions like this one. If you'd just put the bonds where they belong (in taxable) you might have room for the REITs in the tax-advantaged accounts.
Hi EmergDoc,

I assume that you hold this position because bond returns are currently quite low and projected to be so for some time. Is this an accurate characterization?
I'd say it like this...in making asset location decisions, you should consider both the tax-efficiency of the asset class (individualized for you) AND the expected return of the asset class (again, individualized to you.) Making the decision just based on tax-efficiency (as outlined in the Bogleheads Guide to Investing, many posts on this forum, and the wiki until recently) is simply wrong.
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Re: REITs in taxable

Post by White Coat Investor »

House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.
http://whitecoatinvestor.com/asset-loca ... n-taxable/
I'm not trying to dissuade people from using munis in taxable, but the calculation in EmergDoc's blog is a a poor way of making the case for it.

In his example, you have stocks returning 8%/year, and bonds returning 2.16% (tax exempt) or 2.69% (taxable). Great. But if stocks are going to outperform like that, it means that when comparing allocation decisions, any choice that takes significantly more equity risk is going to trounce another that takes less.
Do the calculation for just one year to eliminate that effect, which does not change the conclusion.
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Re: REITs in taxable

Post by White Coat Investor »

manwithnoname wrote:
Now why is it better to hold VNQ in an IRA?
High expected return and very tax-inefficient.
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Re: REITs in taxable

Post by House Blend »

EmergDoc wrote:
House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.
http://whitecoatinvestor.com/asset-loca ... n-taxable/
I'm not trying to dissuade people from using munis in taxable, but the calculation in EmergDoc's blog is a a poor way of making the case for it.

In his example, you have stocks returning 8%/year, and bonds returning 2.16% (tax exempt) or 2.69% (taxable). Great. But if stocks are going to outperform like that, it means that when comparing allocation decisions, any choice that takes significantly more equity risk is going to trounce another that takes less.
Do the calculation for just one year to eliminate that effect, which does not change the conclusion.
OK, but then the question becomes: how small is the "true" effect, and how sensitive is it to assumptions (yields, tax rates,...)?

Extrapolating out to 30 years without rebalancing exaggerates it.
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Re: REITs in taxable

Post by manwithnoname »

EmergDoc wrote:
manwithnoname wrote:
Now why is it better to hold VNQ in an IRA?
High expected return and very tax-inefficient.

but what if you have 40% LTCG on VNQ in a taxable account which will be taxed at 0% ? Please explain.

I am not a white coat so please explain in a way that can be understood under the IRC.
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Re: REITs in taxable

Post by retiredjg »

Back to redjunglefowls question....

In accumulation, I would not hold REIT in taxable. The choices would be:
  • -don't hold any extra REIT at all (because nobody knows if it will help or not)

    -hold it in an IRA (a good choice if you think it will help)

    -hold it in an IRA, even if that forced some bonds into taxable (might be a good choice, might not)

    -hold it in a Vanguard variable annuity (nah...why pay extra for something that might not do anything?)
In withdrawal, if I needed the income to live on, it might as well come from REITs in taxable so I don't see it as an issue during withdrawal. If I had a taxable account, which I don't....
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Re: REITs in taxable

Post by DSInvestor »

manwithnoname wrote:but what if you have 40% LTCG on VNQ in a taxable account which will be taxed at 0% ? Please explain.

I am not a white coat so please explain in a way that can be understood under the IRC.
If you have a LTCG in VNQ that your tax situation allows to be taxed at 0%, that would be a good time to harvest the gain tax free and repurchase VNQ in a Roth IRA. No wash sale concerns when realizing capital gains. Watch out for state taxes though. While taxed at 0% for Fed, LTCG is included in AGI which flows into your state tax return which may not offer preferential tax treatment.
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Re: REITs in taxable

Post by jdilla1107 »

slbnoob wrote:From EmergDoc's post, viewing a 401K as a 0.75 * Roth (since I'm in the 25% tax bracket) was an eye opener. I never thought of it that way. I will have to revisit the asset allocation for my specific situation again when I plan to increase my bond buying next year in my 401K.
This is such a very wrong way to think about it. 25% is your marginal rate now. Your average rate in retirement is probably much, much lower. Probably like 0-8%

Anyone that pays anything close to an average rate of 25% in retirement worked way longer than they needed to. :)

It's hard to think of something worse than REITs to hold in taxable. (Possibly high yield bonds) It is high rates taxed as income and high growth.
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Re: REITs in taxable

Post by FrugalInvestor »

I would not want REITs in my taxable because I'm an early retiree. I've discovered that one of the financial advantages of being early retired is being able to control income and, therefore, taxes and now health insurance costs. I once owned REITs in my taxable and they were not tax efficient in my situation.
Last edited by FrugalInvestor on Wed Feb 19, 2014 8:26 pm, edited 2 times in total.
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Re: REITs in taxable

Post by jdilla1107 »

EmergDoc wrote:
House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.

No, that's completely wrong. The part that is yours is a function of your marginal rate at withdrawal. Not always easy to know without a crystal ball. And more than one rate may apply, if your RMDs span multiple brackets or phase-outs.
That should read, "The part that is yours is a function of your average rate at withdrawal.
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Re: REITs in taxable

Post by jdilla1107 »

EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
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Re: REITs in taxable

Post by abuss368 »

jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
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Re: REITs in taxable

Post by jdilla1107 »

abuss368 wrote:
jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
No, no, no. Retirees want qualified dividends just like everyone else and retirees should be following a total return approach just like everyone else.
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Re: REITs in taxable

Post by abuss368 »

jdilla1107 wrote:
abuss368 wrote:
jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
No, no, no. Retirees want qualified dividends just like everyone else and retirees should be following a total return approach just like everyone else.
Do you not invest in REITs?

If your portfolio is large enough and throws off more cash flow from dividends then you need, total return approach is not needed.
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Re: REITs in taxable

Post by DSInvestor »

abuss368 wrote:
jdilla1107 wrote:
abuss368 wrote:
jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
No, no, no. Retirees want qualified dividends just like everyone else and retirees should be following a total return approach just like everyone else.
Do you not invest in REITs?
If your portfolio is large enough and throws off more cash flow from dividends then you need, total return approach is not needed.
If the portfolio is large enough to throw off more cash flow from dividends than needed, maybe it would be better to hold REIT in tax advantaged and spend the income from stocks (QDI) and tax exempt bond funds.

There are tax efficient options for stocks and bonds to hold in taxable accounts. Are there tax efficient options for REIT other than holding market weight of REIT in broader index funds?
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Re: REITs in taxable

Post by White Coat Investor »

jdilla1107 wrote:
abuss368 wrote:
jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
No, no, no. Retirees want qualified dividends just like everyone else and retirees should be following a total return approach just like everyone else.
That's a good point, you're probably right. Even in distribution qualified dividends are better.
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Re: REITs in taxable

Post by White Coat Investor »

jdilla1107 wrote:
EmergDoc wrote:
House Blend wrote:
blevine wrote:
pkcrafter wrote:Yes, Doc, a little more explanation needed.

No, that's completely wrong. The part that is yours is a function of your marginal rate at withdrawal. Not always easy to know without a crystal ball. And more than one rate may apply, if your RMDs span multiple brackets or phase-outs.
That should read, "The part that is yours is a function of your average rate at withdrawal.
Average marginal=effective. Just semantics. I think we're all talking about the same thing.
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Re: REITs in taxable

Post by abuss368 »

REITs in a tax advantage account will have return of capital and capital gains taxed as ordinar income upon withdrawal.
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Re: REITs in taxable

Post by DSInvestor »

abuss368 wrote:REITs in a tax advantage account will have return of capital and capital gains taxed as ordinar income upon withdrawal.
Tax advantaged can be Traditional or Roth. Holding REIT in Roth accounts would not have those problems.
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Re: REITs in taxable

Post by grabiner »

abuss368 wrote:REITs in a tax advantage account will have return of capital and capital gains taxed as ordinar income upon withdrawal.
However, tax-efficiency is relative. REITs in a tax-deferred account or tax-free account get the same tax treatment as anything else in that account; REITs in a taxable account have a much worse tax treatment than other investments in the account. Therefore, it makes sense to hold REITs in a tax-deferred or tax-free account if you have both.

Another way to look at this is that a traditional IRA on which you will pay 25% tax is equivalent to a tax-free account of which you own 75% and the IRS owns the other 25%.
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Re: REITs in taxable

Post by LH »

abuss368 wrote:
jdilla1107 wrote:
abuss368 wrote:
jdilla1107 wrote:
EmergDoc wrote:If you're in the distribution phase and spending the distributions, sure, why not?
How is being in the distribution phase relevant in any way?
Simple. A retiree needs cash flow from dividends.
No, no, no. Retirees want qualified dividends just like everyone else and retirees should be following a total return approach just like everyone else.
Do you not invest in REITs?

If your portfolio is large enough and throws off more cash flow from dividends then you need, total return approach is not needed.


basically, its better to hold REITS in tax advantaged period.

You shelter the dividends from the tax hit. BUT if you are in decumulation, and your are in a low tax bracket at the margin, have a lot of ROTH say you live off of, then it may not matter in decumulation, since the REIT dividends may not be taxed, or taxed very low/same as business stock dividends.........

whereas in accumulation, with earnings from working, presumptively, at the margin, you will take the REIT dividend hit.

So definitely in accumulation, hold REIT in sheltered.

Likely in decumulation, hold REIT in sheltered.

There are possibly some cases where it would not matter, REIT in taxable versus Sheltered due to tax bracket in decumulation, but I have not run those numbers, to really recommend to someone its ok to go ahead and do it. Would be very situation specific.

Buts its the same thing.

1)accumulation: you get taxed on the dividend, then reinvest whats left after tax

2)decumulation: you get taxed on the dividend, and buy snickers bars and eat them with whats left after tax

Both sides, you want the tax to be as low as possible, more snickers bars or more reinvestment. In decumulation and accumulation, hold REIT in sheltered, business stocks in taxable. This minimizes the tax hit, though in some situations, there may be no difference.
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retiredjg
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Re: REITs in taxable

Post by retiredjg »

above I wrote:In withdrawal, if I needed the income to live on, it might as well come from REITs in taxable so I don't see it as an issue during withdrawal. If I had a taxable account, which I don't....
With all this discussion of qualified dividends vs marginal rate, I was about to throw in the towel and change my mind and even edit my post. You guys have convinced me there is a benefit to not putting REIT in taxable even during retirement. But then I got to thinking.
  • -Most retirees should not have a very large percentage of stocks. Most should have something closer to 25% to 60% of their money in stocks.

    -And most people should probably have only 5% to 10% of their stocks in extra REIT.

    -And many of us believe that a position smaller than 5% is not worth the trouble.
So if an ordinary retiree has 5% of his/her portfolio in REIT and and that REIT fund happened to be in taxable, a portion of the portfolio earnings would be taxed at 25% marginal rate (perhaps) as opposed to 15% (qualified dividends rate) if the person would otherwise have had qualified dividends. I think that might be enough to call "Starbucks money". A difference, yes, but surely less than most people waste in a year.

Even for the many retirees in the 15% bracket, a portion of the earning would be taxed at 15% (marginal rate) as opposed to 0% if the person would otherwise have had qualified dividends. I guess that might be more Starbucks money, but I don't see it as being a very large amount.

I do enjoy the theoretical discussions, but I also like to see how they apply to real life. I just don't see how this will make a lot of difference to most real people.

Of course, the obvious solution is to hold your extra REIT, if you choose to have it, in Roth IRA!
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Re: REITs in taxable

Post by abuss368 »

I went back and looked at the distributions of both Total Stock Index - Admiral and REIT - Admiral for 2013 from a dollar standpoint and also yield. For the REIT fund in particular, I ignored the "return of capital" component as noted on Vanguard's website under "distributions", so as to compare more apples to apples.

In terms of cash flow, a REIT investment in a taxable account still provides higher cash flow (as the yield is higher) after tax than the TSM.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: REITs in taxable

Post by abuss368 »

The frustrating part, and I have yet to receive a logical response on the forum regarding this, is if I selected $200,000 and purchased a rental property. The depreciation expense is eventually gone. No mortgage thus no mortgage interest deduction. The cash flow is taxed at ordinary income tax rates.

Fine.

Take the same $200,000 and invest it in REITs, which are more liquid, and receive the cash flow each year. The cash flow is taxed at ordinary income rates.

On the forum direct real estate may be welcomed and generates a lot of responses. Even if there is no mortgage and depreciation with the income taxed at ordinary rates.

Still, I can not get a practical response of the difference, if any, between the two. This is an inconsistency.

We have been following Rick Ferri's advice about "equal location" rather than "asset location" and this has worked very well for us. We plan to stay the course. An investor must figure out what works for their particular situation based on risks, goals, and time frame.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: REITs in taxable

Post by DSInvestor »

abuss368 wrote:The frustrating part, and I have yet to receive a logical response on the forum regarding this, is if I selected $200,000 and purchased a rental property. The depreciation expense is eventually gone. No mortgage thus no mortgage interest deduction. The cash flow is taxed at ordinary income tax rates.

Fine.

Take the same $200,000 and invest it in REITs, which are more liquid, and receive the cash flow each year. The cash flow is taxed at ordinary income rates.

On the forum direct real estate may be welcomed and generates a lot of responses. Even if there is no mortgage and depreciation with the income taxed at ordinary rates.

Still, I can not get a practical response of the difference, if any, between the two. This is an inconsistency.

We have been following Rick Ferri's advice about "equal location" rather than "asset location" and this has worked very well for us. We plan to stay the course. An investor must figure out what works for their particular situation based on risks, goals, and time frame.
Some one who wants to buy 200K of real estate doesn't really have a way to hold it in a tax advantaged account. Someone who wants to buy $200K of REIT has more options: Traditional, Roth, variable annuity, taxable etc. If one has ample space in all account types, wouldn't it make sense to place holdings in a way that minimizes tax cost? I can see why you choose to maintain stock/bond AA in taxable vs tax advantaged to have smoother account balances in all accounts. I also see that you hold tax exempt bonds in taxable to be tax efficient Unfortunately, there isn't a tax efficient REIT option. Since you hold stocks in tax advantaged, wouldn't it be more tax efficient to reduce TSM in tax advantaged to make room for REIT, and increase TSM in taxable and removing REIT.

Let's say your asset allocation is 50% stocks, 10% REIT, 40% bonds. I view this as 60% stocks/40% bonds. Taxable is 50% Tax Advantaged is 50%. Here's a fund placement plan that holds 60/40 AA in each account but REIT is held exclusively in tax advantaged:

Taxable (50% of portfolio):
30% stocks (tax efficient stock funds)
20% bonds (tax exempt bond funds or tax deferred I bonds etc)
00% REIT (consolidated into stocks in this account for tax efficiency)

Tax Advantaged (50% of portfolio):
20% stocks (reduced stocks to make room for more REIT)
20% bonds (taxable bond funds)
10% REIT (entire REIT allocation 10% of total portfolio)

The larger REIT holding in tax advantaged will give you the 10% REIT allocation for the whole portfolio. I consider REIT to be stocks. In this placement scheme each account has 60/40 stock/bond mix. If your tax advantaged space is much more limited, this may not work as well.

I concede that the dividend income generated by the taxable account will be lower without REIT. If the reduced income is not sufficient for your needs, you can make up the difference by:
1) Selling some shares in taxable. There may or may not be a tax cost to sell shares in taxable depending on a) cost basis b) capital loss carryovers, c) LTCG tax rates, d) state income taxes.

2) Withdrawal from traditional accounts (taxable as ordinary income) but may not be taxed very much given that your taxable account is throwing off lots of QDI and tax exempt income.

3) WIthdrawal from Roth accounts (tax free for most situations).
abuss368 wrote:This is another reason why we converted all Traditional IRA's to Roth IRA's over the past few years. The thought of not paying income tax again is rewarding. No need to worry about RMDs.
If you don't have to worry about RMD's, you may not have much or any Traditional assets. If your tax advantaged accounts are all Roth, wouldn't that be the perfect place to hold all of your REITs?
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Re: REITs in taxable

Post by abuss368 »

LH wrote: Wed Feb 19, 2014 4:40 am In accumulation, I would not hold REIT in taxable.

Vanguard variable annuity would be a consideration.

Have to look carefully at the numbers, costs, er, tax considerations, also the asset protection as a minor benefit.

If you can't shelter, reits become dicey.

.if reits yield 4 percent, at 25 percent tax rate, that's 1 percent tax cost a year, on top of expense ratio cost.(this is a bit of simplification)
What ever happened to LH? Did he leave the forum? Very knowledgeable on many topics.

Tony
John C. Bogle: “Simplicity is the master key to financial success."
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