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Get fancy with MLPs and REITs
Investors who can tolerate some complexity in their investments and tax reporting may benefit from master limited partnerships, or MLPs, and real estate investment trusts, also known as REITs.
"What you'll find sometimes is that the income you get from MLP is return of capital, so that return of capital is not taxable to you. So, a piece of the income might be return of capital. It lowers your basis. When you go to sell the MLP, you will have a higher capital gain," Herman says.
For investors in the highest tax bracket, MLPs can offer substantial tax savings.
REITs potentially offer income as well as tax savings. Dividends from REITs are taxed as ordinary income; dividends in excess of the REIT's taxable income are treated as a return of capital. As with MLPs, the return of capital reduces the investor's cost basis.
"Certain REIT sponsors provide tax-free earnings to investors due to their use of accelerated depreciation on the properties held in the REIT," says Armando Roman, CPA, member of the AICPA National CPA Financial Literacy Commission and managing principal at AXIOM Financial Advisory Group in Scottsdale, Arizona.
"At the end of the year, (unit holders) will get the 1099 stating how much of the income is taxable. You could get $6,000 of income and, because of depreciation, none of it is taxable," he says.