"Tad Borek" <borekfm[at]pacbell.net> wrote
- quote -

That you were talking about some kind of average was not at all clear.

- quote -

Stock prices rise. This is news?

The original poster has to consider the gain in share price (or NAV) with
anything s/he puts into an annuity.

Your point really is not germane to REITs per se.

Caroline wrote:
- quote -

Why doesn't that make sense? You've mentioned a couple REITs, but the
long-term numbers for the asset class, rather than the recent dividend
history of a couple-odd REITs, are more relevant to the question of
where to hold a REIT index fund.

And if you research long-term REIT returns, they may surprise you...a
substantial part of the total return has come from price appreciation.
Half isn't far off..."40% or more" is probably a safe statement for most
periods. The exact number depends on the period of course, and the
benchmark (some include non-equity REITs).

A quick test might be looking at the NAV history of Vanguard's REIT
index fund - is the NAV constant, like a low-duration bond fund, where
all of your return is income? Or does it creep up, like a stock index
fund, where your total return is a combination of dividend income and
(mostly unrealized) gains?

The more you expect REIT returns to come from unrealized capital gains,
the less attractive the VA becomes, if it's being contemplated strictly
because of the tax deferral. The break point would depend on your
assumptions about future tax rates, expected total return (& breakdown
into divs/gains), and the dividends' breakdown into income, gains, and
ROC. Not a simple task...or at least, not a simple set of assumptions.

-Tad

"Tad Borek" <borekfm[at]pacbell.net> wrote
- quote -

You're assuming the REIT stock always rises in value over time.

The "roughly half" makes even less sense now, since you appear to be talking
about share price changes (from purchase to sale) and not the yearly income
REITs pay as "dividends."

snip
- quote -

Yup, like we've said three times now, except it's not true that all REITs pay as
yearly income a return of capital. Some do. Some don't.

Also, some of the capital gains portion of the yearly REIT income paid to
shareholders *is* taxable in that year, not when one sells the stock. See line
13 of Schedule D, for example.

Have you actually held any REITs?

Caroline wrote:
- quote -

No, though ROC does have the same effect. Remember (equity) REITs are
stocks, and like any stock they're expected to rise in value over time.
That appreciation is the source of a good portion of your returns -
perhaps half. You could think of the dividends as the lease payments and
the stock value as the value of the buildings. Not exactly right, but
that's the basic point.

So as a result....

- quote -

....part of your expected REIT earnings are tax deferred anyway, because
those capital gains are only taxed when you sell. Maybe you buy in 1988
for $2.50 a share and sell in 2004 for $6.50/share. When you hold the
REIT or REIT fund in a VA you lose whatever CG tax benefits might exist
at the time of distribution or inheritance.

[As you would with any capital asset. This is a general concept
underlying "VAs or mutual funds?" analyses. If you compare a stock
mutual fund held in a taxable account to an analogous sub-account in a
VA, the winner is dictated by your tax assumptions and the split between
dividends and gains over time.]


- quote -

Don't forget to adjust cost basis for return of capital. That part gets
harder every year!


- quote -

try www.nareit.org

-Tad

"Tad Borek" <borekfm[at]pacbell.net> wrote
- quote -

You're talking about dividends paid as "return of capital," right?

If so, I suspect the "roughly half" is a post-o. Some REITs rarely if ever have
a return of capital. Other REITs will vary the "return of capital" amount quite
a lot each year. It depends on how the year went for the REIT and what it's
trying to do with its shareholders.

- quote -

Only when one sells the stock.

- quote -

I'm having trouble parsing this sentence, but here's my experience:

For 2003 the dividends for my two REITs were divided into five categories:

"ordinary" portion
15% Rate Gain
20% Rate Gain
Unrecaptured Section 1250 Gain
Return of Capital

I believe the "20% rate gain" goes away in 2004. (Too lazy to search right now,
but I know a lot of the nastiness of this year's tax forms for investors was due
to the mid-year tax law changes.) The effect of the above categories comes
through mostly on Schedule D, and in particular, the back side of Schedule D.

The first time completing one's tax forms for REITs is a pain. It's easier every
year, though. And of course one can always pay someone to do one's taxes. Or the
software Turbotax seems very user friendly, even for REIT shareholders.

Most importantly, as I think Tad was trying to say, the tax one will pay on a
REIT may very well be due to mostly Schedule D capital gain considerations and
thus be at a much lower rate than ordinary income.

For now, anyway. :-)

In sum, I still wouldn't be so keen on putting a REIT investment into an
annuity, in the name of saving on taxes. I'm still doubtful that savings is
there to be had.

As always, comments welcome. Maybe this thread will become an adequate partial
substitution for a much-needed _REITs for Dummies_ manual...

matt noone wrote:
- quote -

There's certainly some sense to holding REITs and bonds in tax-deferred
wrappers, for the reasons you describe. So if you're thinking of the
Vanguard REIT index fund, the VA equivalent is worth a look.

Some considerations:

* It sounds like your plan is to invest $5k per year. If your only
reason for the VA is the tax deferral, you'd get it in the IRA, at lower
cost. You could put $3k in an IRA ($4k starting in 2005). Sounds like
it's not deductible, but neither is an investment in a VA.

* Tax deferral helps you only to the extent your returns come from
ordinary income and realized capital gains - the dividends. But not all
REIT returns are income, roughly half have come from capital gains that
are taxed only when you sell. And as Caroline mentioned many REITs have
been returning capital as part of their dividends...that portion of the
dividend becomes taxable capital gain as well. So as long as there
remains a lower tax rate on long-term capital gains, you'll end up
paying a higher tax rate on that part of your earnings, if you hold
REITs in a VA (the VA wrapper converts all earnings to ordinary income).
Similarly if the assets are inherited you lose the "basis step-up".
These are similar concerns to those with any stock really, but they need
to be factored in when you're figuring out the horse race between the VA
(or IRA) and a taxable account.

* to the extent you have an opinion about future tax rates you might
want to pay taxes now, to avoid high taxes in the future. Both the
future tax brackets, and where you'll land in them at distribution time.
This depends in part on what type of retirement income you anticipate -
many retirees have very low income so it's kind of academic what the tax
brackets are. But tax deferral can in some circumstances be a disadvantage.

-Tad

"matt noone" <mtnoon1[at]netzero.com> wrote
- quote -

Many REIT companies' dividends are more complicated than this.

Typically the total dividend a REIT shareholder receives breaks down into a few
categories for tax purposes. As a result, often there is a tax advantage to
owning a REIT. This is part of the appeal of REITs, though admittedly since the
change to the dividend tax law (which does not apply to REIT dividends) around
May, 2003, one can argue REIT dividends are less attractive. But less attractive
than non-REIT dividends? Not necessarily.

In my experience with two REIT companies, the breakdowns of the previous year's
dividends are announced by the REIT companies in the first week of January or
so. (The law undoubtedly says something about when companies must announce
this.)

If you prefer a mutual fund of REITs, then study the prospectus and see exactly
how its dividends have broken down for tax purposes.

You write that the Vanguard annuity charges 0.69%. But if you hold a REIT mutual
fund within this annuity, don't you have to figure in the mutual fund's expense
ratio, too? Or maybe I'm not following what you say.
VGSIX and VGSLX have expense ratios of 0.27% and 0.21%, respectively...

In any event, in a taxable account of REITs, you'd likely lose something *less*
than the (7%*0.31 =) 2.2% to taxes. It might be very competitive with your
proposed, Vanguard annuity plan, so I'd investigate a bit further. I suspect the
decision might come down to personal preferences. E.g. how comfortable you are
with the withdrawal rules of the annuuity vs. the flexibility of holding the
REIT funds in a taxable account.

I look forward to further commentary as I am contemplating more REITs in my
portfolio, too.

- quote -

On Wed, 3 Mar 2004 05:40:27 CST, mtnoon1[at]netzero.com (matt noone)
wrote:


- quote -

Have you considered a non-deductible IRA (for '03 and, if necessary,
'04)? It has some of the nasties of an annuity (ordinary taxes, no
step-up in basis, illiquid), but at least you dodge the cost of the
wrapper.

Just watch the IRA and low balance fees.



-HW "Skip" Weldon
Columbia, SC

I want to increase my REIT exposure. The problem, of course, is that
REIT dividends are taxed at ordinary income tax rates, not the more
favorable capital gains rates. Assuming a 7% annual return, and a 31%
combined state and federal income tax rate, I would realize an annual
return of 7% in a tax-deferred account v. 4.8% in a taxable account.
Based upon a $5,000 annual investment, the difference is approximately
$100,000 in twenty years, and $400,000 in thirty years.

I do not qualify for IRA's due to income limitations, and a Reit fund
is not an option in my 401k. Therefore, I am considering buying a
Vangurd Annuity to invest in its REIT index fund. This is investing
money that I won't need until retirement, so I'm not concerned about
penalties for early withdrawals. The fees in the Vanguard variable
annuity are .69%, which is far less than most REIT mutual fund
expenses. There are no surrender fees and no sales commissions.

The only potential downsides I see are: 1) If Congress changes the
law to make annuities no longer tax-deferred; or the REIT market tanks
for a pro-longed period of time, thus making them an unattractive
investment opportunity. I do not consider either of these likely
possibilities--I believe the Clinton tax change proposal to annuities
was to make transfers inside the annuity taxable. I intend to invest
only in the REIT index, so there should be no subsequent sales.

To me, this strategy appears to be a no-brainer, which of course
scares me. That's why I would welcome any comments or criticisms of
this investment strategy from the people on this board.