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Closed-End Fund Distribution Tax Character Mistakes And Misunderstandings



  • There are three primary things that I see a lot of newer CEF investors get hung up on; return of capital, section 19a and data aggregators distribution classifications.
  • All three of these have to do with the tax character of the distributions and the mistakes that can be made.
  • These are important things to take note of for investors holding in a taxable account.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

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Written by Nick Ackerman, co-produced by Stanford Chemist

Closed-end funds are an excellent way to generate income, use as arbitrage exploiting premiums/discounts or gain exposure to illiquid assets that wouldn't normally work in traditional mutual

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This article was written by

Nick Ackerman profile picture

Nick Ackerman is a former financial advisor using his experience to provide coverage on closed-end funds and exchange-traded funds. Nick has previously held Series 7 and Series 66 licenses and has been investing personally for over 14 years.

He contributes to the investing group Learn more.

Analyst’s Disclosure: I am/we are long BSTZ, HTD, BUI, EXD, JRS, ETW. 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.

This article was originally published to members of the CEF/ETF Income Laboratory on March 26th, 2021.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (130)

Thank you for a very useful article. One question for an investor entering my first tax year with MLPs and CEFs: If a CEF invests in MLPs does the individual owning the CEF have to deal with K1s? (Lots of abbreviations I've never used before.)
Retired Investor profile picture
@PrinceGardner I have never found a MLP owning fund (CEF or otherwise) that required K1. Check the fund’s description or Prospectus for certainty.
Nick Ackerman profile picture
@PrinceGardner as @Retired Investor was leaning towards - you will not receive any K-1 forms with a CEF. They all issue 1099s. That being said, some ETFs issue K-1s.
@Nick Ackerman - which ETFs issue K-1? I have not read of that. I do know partnerships issue out K-1 forms
Thank you, Nick for a very informative article. How well does Pimco mgt manage ROC in their closed end funds?
Nick Ackerman profile picture
@47845185 thank you! From the fund's I'm most familiar with, they don't show a lot of ROC. It is mostly ordinary income.
@Nick Ackerman

Thank you, Nick.
I think your point about a growing NAV versus an eroding NAV in regard to evaluating ROC is essential--it's been made in other articles but needs to be remembered. For example, one of my holdings, MGF, seems to be suffering from eroding NAV and thus destructive ROC, with the dividend decreasing month to month.
Nick Ackerman profile picture
@jazznut indeed! Definitely an important topic and discussion. MGF, I believe, can be nice during certain short-term time frames. Also, if you have some reasonable expectations. It holds a lot of Treasury exposure, thus, the 7.4%+ distribution rate seems high at this time.
@jazznut I sold my $MGF and cut my $MIN by half because of the eroding NAV. I think it will come back in the future. At which point, I'll get back in. As @Nick Ackerman says. It can be very good during certain short-term time frames. Short-term could be 2 years which was about how long I last owned it (Sold in Dec-Jan).
The discussion of updated 1099s each year reminds me of a situation I had with eTrade. I have mostly closed end funds in my portfolio, and have had for twenty years, and I typically get an original 1099 plus two updates, or three sets, the last one generally in March. I used to call eTrade and ask when the updates were scheduled so I knew when to do my taxes, and the person always wanted to know why I needed an update, "Has there been a mistake?" was the constant question. When I explained that the income from closed end funds would often be restated as other types of income, the eTrade people never seemed to understand the concept. Now I don't call them. I just wait for the 1099s to come.
Nick Ackerman profile picture
@DanThomasNelson yes! All we can do, unfortunatley. Just not a lot of support for CEFs as they are misunderstood.
Great article, I found it to be very informative. Interestingly, (though not surprisingly) the “data aggregator” problem is certainly not unique to CEFConnect/Morningstar. Last week, I was shocked to learn from a well regarded SA contributor writing about QYLD (an ETF) I had been looking at, that ~82% of the ETF’s 2020 distribution was ROC, as I had researched the ETF on Fidelity which reports 100% of the distribution for 2020 as “dividends”. I then researched the Fund documents for myself on their website (where the contributor told me they got their info) and obviously found the SA contributor to be correct. I wonder now if Fidelity is getting their data from Morningstar, too(?). Just goes to show that you really have to do your research thoroughly and go directly to the “original” source to verify the data.
Nick Ackerman profile picture
@ALoverofSmoothJazz indeed! It is a problem across the board - not specific to just Morningstar/CEFConnect. Though some of the data can be utilized, we just need to pick through what is good data and what can be ignored.
Retired Investor profile picture
For ROC data, I go to the sponsors site as Fidelity seems to lump it all together.
Nick Ackerman profile picture
@Retired Investor absolutely! Need to go to the fund sponsors' website just to confirm. It is another step, but I see too many people falling victim to incorrect information. (Even our own fellow contributors, though won't name names - hopefully, they read this too!)
How about tax reporting from brokerage companies for ROC? Has anyone had any problems with inaccurate year-end reporting?
Retired Investor profile picture
@LowerForLonger Occasionally Fidelity has had to send out corrected tax statements. They usually are final by mid-March so I wait to file until after the 20th. Changes after that are rare and usually small enough not to be troubled about.
@LowerForLonger I get 3-5 corrections every year from TDAmeritrade. The final one comes in may the last two years. I delay my taxes to the fall due date which necessitates one runs your estimated taxes and pay a buffer to avoid any penalties. Hasn't been a big issue for me yet
Nick Ackerman profile picture
@LowerForLonger as others mentioned, it isn't a tax year for a CEF investor until they get the third or fourth corrected 1099. It can be frustrating if you want to get your taxes filed right away. For me, I just wait until the beginning of April when I do my quarterly payments as well.
What about THW where NAV has declined for many years due to an exorbitant distribution
@integritycoatings I hope somebody will answer your question.
Jcb331 profile picture
@JANFA @integritycoatings I'm not sure why you guys keep harping on THW nav. From SA graphs: XTHWX NAV only graph

07/2015-07/2016 -10.8%
04-2016-04-2201 5yr---+27.5%
04-2018-04-2021 3yr-- + 23.02%
04/2020- 04-2021 1 yr--+ 13.2%
10-2020- 04-2021 6 mo---5.39%
03-2021-04-2021 1 mo--- 3.6%

So THW is earning its distribution in all cases except the first year.
No DIV cuts in its 6 year history. it may not be growing much but it is earning its distribution. and with tax free ROC it adds even more value to the distributions.
@Jcb331 I am retired and I like the THW steady distributions but would like to be sure that the ROC is not destructive. I am not a financial specialist to analyze ROC so I go with a recommended rule of thumb - checking NAV over time whether it is dropping or rising. I looked at the NAV chart at Fidelity and the NAV values were dropping since the beginning of the fund as follows / 1 year intervals/:
7/31/2015 - $19.14
7/29/2016 - $16.60
7/31/2017 - $15.69
7/31/2018 - $14.89
7/31/2019 - $13.66
Then the NAV reached the lowest point in March 2020 - courtesy of Covid 19, and it keeps rising from there. I bought THW in April 2020, and am adding some now.
I plotted values of shares of companies that THW currently contains against xTHWx for the period of existence of THW. Most of the companies saw their share value going up since 2015 - like for example JNJ, a few, like NS and BMS followed xTHWx.
I am hoping the NAV of THW will stabilize, because I like the income but not dropping NAV.
misscbd profile picture
Thank you for another informative article.

I have a few dumb questions. First, does the "buy/write" designation mean the fund deals exclusively in stock *indices*?

Also, does ETY differ from the Buy/Write funds you mention because they do not option trade *exclusively* in indices but also in stocks?

Your article made me think further about the BUY/WRITE cefs: ETV, ETW, EXD mentioned and how they compare to the other EV fund, EOS.

Am I missing something or does EOS only write call options, etc. on stocks and not indices?

Since indices obviously reflect the current market and can rise or drop markedly, I'm thinking that can negatively affect those funds during a bear market more than a cef that doesn't trade the indices but instead trades around individual stocks.

There's so much to learn -- appreciate your articles and the clarity you provide.
Nick Ackerman profile picture
@misscbd thanks for reading!

1. Something I always wondered too. That is because when someone says they use a buy-write strategy - I always thought it meant they bought the stock to write calls against that individual position. In this case, it is buying the stock, then writing against an index. So, I guess it can be more flexible than I originally would have guessed.

2. ETY does write calls against indexes. Here is an easy breakdown for all of Eaton Vance's funds. funds.eatonvance.com/...

3. Reading that PDF above, you will note that EOS writes against underlying positions in the portfolio/individual positions. That is why they don't show ROC in their distribution as much. Though they do for other reasons (such as just not realizing enough capital gains and leaving positions as unrealized - means they still "earned" their distribution - they just haven't realized it yet.)

4. Absolutely right, even in a not very volatile market as the market just rises naturally upward - that generates losses on the option sleeve of their portfolio. At the same time, a lot of their underlying positions are rising - enough to offset the said losses. Then boom! You get ROC because they had realized losses - while NAV rose or stayed relatively flat due to the underlying unrealized appreciation.

I hope this helps! Let me know if anything else comes up.

We do a ton of educational articles at the CEF/ETF Income Laboratory. Not trying to do a sales pitch but there we have a "Library" and you could literally spend years reading through the pieces and learning. We are also always there to help with any questions in a live chat. (Yes, this is a bit promo but just thought I'd put it out there if interested. Of course, always feel free to reach out via comments on articles as well - as you have here. Though a bit harder to explain without being able to include images and such as we could in a chat. seekingalpha.com/... )
misscbd profile picture
@Nick Ackerman
Thank you for this detailed response.

I see that the funds I hold writing against indices (ETY, EXD) seem to have more fluctuation in distributions (regardless of how they accumulate the $$ for dispersement :). I love your explanation of why this can happen.

I really appreciate the EV link info because I was considering adding to EXD but now that I understand buy/write a bit better, I will stick to my original preference (when I bot EOS in 2015) and let my small EXD opening position sit as is. ETY is now a full position and I'm okay with that but will not add shares.

I notice UTF and UTG, while not "tax-managed", had distributions classified as "qualified" and the rest was Capital Gains. For that reason, I expect to add to those if/when they are not at a big premium and have placed BUI on my radar too.

It would be nice if they were all in IRAs but unfortunately, I have less $$ in that one so I have to buy some shares in the taxable.

Prior to joining SA I had no interest or understanding of these things. I hope it's true that learning new stuff increases that magic juju in senior brains, reduces the bad amyloid placque things and keeps us from forgetting our names because my "left" brain has Never been used this much, ever!!! :0
surfgeezer profile picture
@misscbd First I agree with Nick's, but let me just add- since I do use options extensively in my portfolio also and hold several CEF's that do.

Writing an option is basically just guaranteeing a price- at a certain time, and getting paid a "Premium" for that "guarantee". It is basically very much like an Insurance product.

As the insurers, they get cash up front- for the time period- with no way of actually "knowing" what will happen. That's universal.

So... that cash received is by definition simply unrealized and unknown how much will have to be "paid out", it is an unrealized "cash pool" that can be used immediately.

What ALL Insurance companies depend on is the CONTINUING incoming Premiums, as well as how well they use the already paid Premiums. That's the big deal.

That continuing part is as big a deal as how well its used because of what is called Theta- time value. Think Insurance policy cost for 1 year vs 1 month- obviously less. THAT "time" change coupled with the continuing is the big deal.

We all know price is volatile and can easily outrun a stocks dividend, well sold options are a multiple of that same thinking.

Meaning, as an Income investor, I am fine with accepting, in the short term, the fact I could buy something and have price go down more than my div- BECAUSE I know the div will continue and be EVENTUALLY outrunning the price change. Same with options.

So if I buy a stock and immediately sell a Call for a set price higher, I am by definition "making money". HOWEVER, if that stock goes higher than my Premium I will "lose" money on that contract-BUT I can in fact simply wait for time to go buy and then roll that contract to add more "time". Adding more time should add more cash $ by definition ( as explained above)- BUT by closing/realizing that first contract I would book a realized loss AND have more unrealized cash STILL in my "pool" to maybe pay divs or buy stocks> WITH a HIGHER GAAP realized price on that next contract (change in price of the stock (Delta) + new time (Theta)).

SO.... I "lost" money on the first contract and hopefully also collected a divvy by still owning the stock, then I get a new one with a net higher price and that is simply unseen in the reports because it is technically "unrealized" cash. Repeat, repeat, repeat.

It does show up in NAV as a NEGATIVE because accounting demands they always show the immediate "buyback" along with that one time offsetting cash on each contract.
On a Call, as the stock price rises the option "buyback" shows a higher "loss" and gains when the stock price drops. By definition a buy/write is DELIBERATELY offsetting stock gains with taxable "loss's- OR if the stock stays flat boosting the div cash payout with Time burn.

That's a big deal as far as watching the NAV, because, if done correctly, the option "losses" are again going to improve with time as they get rolled ( time)- maybe even into ever higher strike prices that will show possibly less unrealized cash pool bumps. Maybe not.

The real deal is looking at the changes in the unrealized cash pool YOY- which are very hard to see with most CEF's. The realized/unrealized is just accounting crap as each contract reflects the stocks price change. My personnel unrealized "pool" ( Calls and Puts sold ) is currently sitting at 1.59 X my estimated divs. That would be the salient point- the unrealized pool can be bigger than what I expect in divs easily. It can also easily be bigger than the actual stock gains and is by definition just unrealized cash sitting and deployable.

WHY these funds have such a large % in ROC is simply because know one can know what that unrealized cash ( constantly churning)) in the "pool" will do and the "pool" itself is simply unrealized prepaid $.
Nick Ackerman profile picture
I published an exclusive article yesterday to members of the CEF/ETF Income Laboratory. It is around the same topic, but going into what the tax characters can all mean - their benefits for a taxable account or the not-so-beneficial distribution classifications (ordinary income, short-term capital gains...) seekingalpha.com/...

Consider joining the CEF/ETF Income Laboratory today and getting an early look at the article! Free 2-week trial available for those interested. seekingalpha.com/...
littlecubbie2019 profile picture
Thanks for article. I appreciate you clarifying these subjects.
Nick Ackerman profile picture
@littlecubbie2019 glad you enjoyed! Thank you!
Dick Cod profile picture
The misleading generalization (straight from the ancient and definitively incorrect EV "thought piece," perhaps?) that a declining/eroding NAV signals the CEF is just giving you your capital back is easily demonstrated to be false. Consider...
A CEF portfolio composed of one or more coupon bonds will ALWAYS suffer a declining NAV as interest rates rise. However, the coupon cash flows remain unaffected...so if net interest income covered the distributions before rates rose, they will continue to cover the distribution after rates rise despite a decrease in NAV.
Further --- in an unrelated type of NAV reduction -- CEFs may distribute special / extra year end distributions composed of either realized gains or additional interest income. Such extra distributions DO reduce NAV but clearly DO NOT signal that the fund is no longer capable of supporting continuing regular distributions with interest income or gains.
It's important to avoid facile generalizations and get this stuff right to avoid making poor investment or trading decisions.
Regards, Dick
Nick Ackerman profile picture
@Dick Cod thank you for the input!
'That always made me chuckle a little bit, as I really don't know where they (CEFConnect) are getting their information (making it up out of thin air?)'

That's a good question! Thanks for the article
Nick Ackerman profile picture
@clrodrick I emailed them, I know they get their information from Morningstar - but where are they getting it as it doesn't match even section 19a files! So always was curious.
ManWithoutName profile picture
ETV is a core holding in my taxable portfolio due to most of it's distribution being classified as ROC. I'd also echo an earlier comment about waiting on filing your taxes for the year if you have an investment with high ROC, as the first 1099's can have a distribution classification shown incorrectly.

Investors that dismiss these investments simply because they have a portion of their distribution labeled as "return of capital" are not doing themselves any favors by paying higher taxes.
I love my ROC taxable funds.
Good point on waiting to file your a Income Taxes
I received 3 corrected tax forms from my Broker, the last on March 10
dashriprock2 profile picture
Great analysis, thanks.
Can you advise a reliable source for finding the end of day NAVs for CEFs?
Also, ROC is it true that diminishes our tax basis?

Yes, ROC reduces basis.
NAVs for most CEFs can be looked up by adding an X before and after the ticker symbol. (eg. for DNP, XDNPX).Yes, ROC reduces your tax basis.
NV_GARY profile picture
Actually- that is one thing that cefconnect does well - end of day NAV.
I am watching BSTZ closely. I will probably start a position in the next few months. I do not understand why there is a big difference in the NAV of the BST vs BSTZ funds..Any comments.

Nick Ackerman profile picture
@Jmzol2067 I'm not sure exactly what you mean about having a difference. They are two different funds. I'm long both of them! Thank you and good luck!
hawkeyec profile picture
@Nick Ackerman

Thank you once again for being SA's resident expert on CEF distributions, among other things. A couple of extra comments. First, I love non-destructive ROC (and sometimes even the destructive kind). I have 50 CEFs and many reported large LT gains and ROC distributions this year, all of which helped push my tax bill down. I just love writing income on my 1040 and then looking up at the little box on top of my Turbo Tax program and seeing no change in the tax bill when the income goes in.

The things you mention in this post can cause some irritations however. By law I am supposed to receive 1099s by mid-Feb. I do, but virtually all the ones with securities data tell me they are not final numbers. Corrections will be coming. This, of course is for reasons you have explained here. I had 45 changes in reported income classifications this year (so far; hoping they are all there is). Those corrected reports didn't come until two weeks ago so I was unable to finish my taxes until I was sure all the data was in. Also, I had many surprises this year, huge unexpected capital gains distributions, from UST mutual funds, of all places, and CEFs. If I bother to check, Vanguard usually forewarns me of gains distributions up to a month early (unfortunately I forgot to look this year). I don't know if CEF sites pre-warn also.

Finally, you mention MLPs as a source of ROC, sometimes destructive. I bought AMLP at the IPO and added to the position many times over the years until it got quite large. Even though much of the distribution from this fund was from ROC sources, that is the point of MLP's, to lower taxes on other investment income. I just sold the whole position this year and in true fashion, it proved to be a gift that keeps on giving, in spite of falling NAV, and a corresponding decline in basis, I managed to take a nice loss, erasing all of my surprise capital gains distributions and a huge gain on a strip treasury. Meanwhile, my net earnings on this stock, including positive tax benefits, have been among my best over the years. When the energy picture settles I am thinking of doing a reset with ALMP or a cousin or two.
@hawkeyec I love happy endings
@hawkeyec - a few commentators from other SA articles implied holding a CEF that has a fiscal year end that does not match up with calendar year end (Dec 31) can potentially have an issue where it issues corrected 1099 well after tax deadline. Ever since reading that I have been careful to only select CEFs for my taxable account that have fiscal year end of Dec 31. I hold a few that are not aligned and likely will sell them once I classify for LTCG and move money into similar fund with an aligned fiscal year end.
Nick Ackerman profile picture
@hawkeyec always appreciate your thoughts! Thank you for taking the time to share your thoughts.
CEFs are a significant portion my investments and I also find lack of knowledge amongst brokers who are extremely reliable and experienced. So I tend to invest in funds with good reputations and usually do

not reduce dividends. PIMCO, Guggenheim, Cohen and Steers are some examples. In addition I consider Nick to be one of the more knowledgeable SA contributors as he answers questions rapidly. In addition there number of intelligent commenters who provide ideas. Finally, I try to invest in a number of different CEFS to provide some diversity.
Nick Ackerman profile picture
@villanema agreed! Thank you for reading. Good luck with all your investments!
kyle191 profile picture
@villanema ...I used to think that way about Cohen and Steers until their MIE fund got obliterated! There is a share holder vote to liquidate the fund at the NAV. So if you bought any time above $3.50 you will get shellacked.

I have written repeatedly to C&S about why the fund is liquidating and all I get back is a canned response "blaming Covid."

When MIE liquidates, it will be my single biggest loss in my investing career. I purchased in the $7.00 range
Nick Ackerman profile picture
@kyle191 I don't blame C&S for MIE, personally. It was the whole sector that just got annihilated. Several liquidated in the space or did reverse splits.

I also believe, though it seems like an unpopular opinion, that you could simply move that capital somewhere else. To another MLP focused fund and you would be able to participate in the rebound if it should continue. If it is held in a taxable account, even better - you now have losses to offset some gains you could realize.

Though I understand your frustration. It is liquidating because it just simply isn't large enough for them to concern themselves with at this point.
Great article. In the past, I didn't invest in CEFs because of ROC and management fees. Fortunately, I had time in retirement to figure out these issues to the value of CEFs.

Does a person have to continuously trade them to avoid destruction of NAV? I see some funds to are able to maintain NAV, ie., BME, BST, etc.
Nick Ackerman profile picture
@jasonjones thank you for reading and the comment! I don't think that trading is necessarily required. As you mentioned only a few of the fund's higher NAV now than at inception. With the latest rally since March lows last year - there are now quite a few funds in that category.
@Nick Ackerman Yes, CII is a it's initial price and BDJ is headed that way although these are unusual times.
@Nick Ackerman yes alot of CEF's now have wonderful year NAV returns that readers love to tout , hard to imagine an equity CEF that doesn't have a growing NAV . Folks need to take a longer time frame to see if the funds managers distribution policies are too generous ,sooner or later there will be a bear market or an extended sideways market, that will quickly separate out the better funds . Its still surprising how many funds even now have lower NAVs than they started with
Jcb331 profile picture
I always wonder where the origin of the misconception about ROC started. Is it financial advisors that just don’t know any better and give their clients bad information? Is it banks and brokerages that pine for clients and thus scare them to enroll in their services. Is it a carryover from the 2008 financial crisis where I assume a lot of CEFs were paying ROC with declining NAVs?
Universal Huckleberry profile picture
@Jcb331 I think the misconception lies in the name itself: "Return Of Capital". The idea of getting your own capital back in the form of a so-called distribution sounds a lot like a ponzi scheme.
Nick Ackerman profile picture
@Universal Huckleberry right! I think that does cause some confusion. Perhaps why others classify it as "nondividend distribution."
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