myICLUB Blog

ICLUBcentral has long maintained a recommendation that investment clubs stay away from certain "problem securities" in their club portfolios. On this list are Real Estate Investment Trusts (REITs), publicly-traded companies that invest in real estate and, if they adhere to certain regulations, are eligible to pay no U.S. federal corporate income taxes on their profits. REITs typically pay attractive distributions to unitholders which adds to their appeal for investors.

It's these distributions that create complications for unit-value accounting. REITs don't typically pay "dividends" to unitholders. Instead, their quarterly (or, in some cases, monthly) distributions are made up of a mix of transaction types: Capital Gains, Returns of Capital, and Ordinary Income (Dividends) are most common. But REITs may also have report distributions in other categories, such as Unrecaptured Section 1250 Gains, Section 199A Dividends, or Section 897 Capital Gains. Each of these carries its own tax implications for unitholders and will be reported on the Form 1099-DIV that brokerage firms provide to customers each year.

The complex nature of these distributions is what creates problems for unit value accounting in which a portfolio and the partnership's unit value are revalued monthly. When received, a REIT's dividends are recorded in the partnership's books as "Dividends." But after year-end, the REIT will release the classification of distributions paid in the prior year, usually sometime in late January or early February. This announcement will detail how much of each quarterly distribution is made up of Capital Gains, Returns of Capital, Ordinary Income, etc.

The club treasurer will need to track down this announcement (which is usually published on the REIT's website, but isn't always easy to find or published in a timely manner). The treasurer will then need to edit each quarterly distribution already recorded, and add the other distribution types. (In myICLUB.com, you can add several Types to any single distribution when adding or editing a Distribution transaction, which helps.) Uusally, this takes some additional calculations in Excel to make sure that, after rounding, the total of the distributions paid each quarter matches the new total of all of the different distribution types that are being added to the books.

That's not all of the data massaging that's required -- some of the distribution amounts, such as Unrecaptured Section 1250 Gains, will be recorded separately when the treasurer performs the annual allocation of income and expenses function in myICLUB.com.

Once all of the REITs distributions have been properly edited, the income, capital gains, and returns of capital are ready to be passed through to the partners so that each partner's IRS Schedule K-1 and the club's Federal Form 1065 filing are all accurate.

You can see why many treasurers are not thrilled about the extra work that a REIT investment in the club requires. If the treaurer ignores the task of this recategorization, their IRS tax filings will not be accurate and the partners will likely be paying unnecessary taxes on their income from the club.

The fact that a REIT's quarterly distributions are being recategorized after year-end has another ramification, on members who have taken partial or full withdrawals during the year. Those withdrawals were based on the partnership's taxable income and valuation at the time of the withdrawals, but after the REIT distributions were recategorized, the valuations throughout the year will change as well. For a small REIT position and a small member withdrawal, the difference may be imperceptible. But for a large amount of distributed income, the discrepancy could be more significant, and there is often no realistic way to adjust the payout of a past member withdrawal.

For individual investors, this reclassification isn't a concern since they only need to worry about accurate tax reporting for the entire year. But for investment clubs, the additional complications outweigh the benefits.

Other problem securities that present issues for partnership account for other or similar reasons include master limited partnerships (MLPs), royalty trusts, publicly-trade partnerships (PTPs), cryptocurrencies and securites that hold them, and exchange-traded funds that directly hold commodities or precious metals. ICLUBcentral support is limited for these securities, and they are not supported in the myICLUB.com Club Tax Printers.

• DOUG GERLACH

Doug Gerlach is President of ICLUBcentral Inc. and the author of Investment Clubs for Dummies.