Doug Carey for Seeking Alpha writes: Many investors who are fans of mortgage REITs are pointing to the
possibility of a near-perfect scenario: The Federal Reserve stops buying
mortgage-backed securities (which would mean higher yields on
mortgage-backed securities) but keeps short-term rates extremely low. This
would be the sweet spot for mortgage REITs because they would be able
to continue to borrow money cheaply, but can then invest in higher
yielding mortgage-backed securities. In other words, their spread would
increase and thus their profitability.
Even though many mortgage
REITs pay a nice dividend, investors are sometimes surprised by the
hefty tax bill. REITs are taxed at ordinary income tax rates if they are
in taxable accounts, which takes a big bite out of the total return for
many. But there is a way to get around this tax bill if an investor has
capital losses he can use. I call this strategy dividends to capital
gains conversion.
The idea is this: By taking dividends in the
form of capital gains, and then offsetting those gains with capital
losses you may have, you can pay an effective tax rate of 0%. Compare
this to paying either the 15% rate for qualified dividends (for most
people) or your top marginal income tax rate on REIT investments.
So
how does one go about converting dividends to capital gains? It takes
some monitoring, but it could very well be worth your time. First let's
define the ex-dividend date for a stock:
The ex-dividend date is
the day on which all shares bought and sold no longer come attached
with the right to be paid the most recently declared dividend. This is
an important date for any company that has many stockholders, including
those who trade on exchanges, as it makes reconciliation of who is to be
paid the dividend easier. It is just as important for investors,
however, since you must own a stock before the ex-dividend date in order to receive the next scheduled dividend.
If
an investor buys the stock on the ex-dividend date or after, he is not
entitled to the next dividend. This also means that if an investor sells
the day before the ex-dividend date, he is not entitled to the next
dividend.
Given this, an investor can buy a stock the day of the
ex-dividend date and sell the day before the next ex-dividend date, and
be assured that he will never receive a dividend. Some might be saying
what a horrible deal! But Mr. Market is no dummy. Those who buy on the
ex-dividend date and sell the day before the next one will benefit from
the stock price climbing by the amount of the dividend during this time.
If you ever notice why a stock's price drops the of the ex-dividend
date, this is because those buying it on that day will not receive the
next dividend. In fact, the price drops by the amount of the next
dividend. Conversely, the stock price will begin climbing the day after
the ex-dividend date and will eventually rise by the amount of the
dividend. Of course, the price will fluctuate due to other variables,
but the amount of the next dividend is always embedded in the price.
Hopefully this all makes sense because for stocks with high dividend
yields, as this strategy could provide a huge gain for investors. Let's
take a look at how this strategy might be used with Annaly Capital (NLY), which has a dividend yield today of 11.5%.
Every
quarter if I buy NLY on the ex-dividend date and then sell it the day
before the next ex-dividend date I pay no taxes whatsoever on this
dividend, yet receive all of the dividend yield in the form of capital
gains. I avoid taxes by offsetting the gains with capital losses. This
is a huge benefit to me because NLY is a REIT and investors must pay the
full income tax rate on any dividends that are paid.
Let's look
at an example using NLY where an investor buys 5,000 shares. The
combined marginal federal and state tax rate for the investor is 33%.
The investor is able to offset all capital gains with capital losses and
pays $8 per trade. I ran the following using our publicly available
calculator called Minimize Taxes by Trading Dividends for Capital Gains and readers are free to run their own scenarios as well.
I will have accumulated nearly $63,000 more over 10 years using this
strategy. That is a cumulative return that is 80% higher than if I just
collected the dividend. I can also adjust the amount of the capital
gains that I can offset. Let's say I can offset 50% of the gains with
capital losses. It is still worth it because this strategy delivers a
49% higher return than not using the capital gains conversion strategy.
Other REITs where this strategy would work well are American Capital Agency Corp. (AGNC), New York Mortgage Trust (NYMT), Dynex Capital (DX), Anworth Mortgage Asset Corp (ANH), and Hatteras Financial (HTS).
Ticker | Dividend Yield |
AGNC | 15.7% |
NYMT | 15.0% |
DX | 11.2% |
ANH | 9.9% |
HTS | 10.3% |
Because
of the monitoring involved and the trading costs, this idea is best
suited for those stocks with relatively high dividends. In the example
above, if the dividend yield were below 2%, this strategy does not pay
off any more. But for REITs and other high yielding stocks, especially
those where dividends are taxed at your income tax rate, this strategy
will be a sure-fire winner.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NLY, AGNC over the next 72 hours. I
wrote this article myself, and it expresses my own opinions. I am not
receiving compensation for it (other than from Seeking Alpha). I have no
business relationship with any company whose stock is mentioned in this
article.
0 comments:
Post a Comment