Jon from MN posted over 15 years ago:

—06/25/11 This is something that was just forwarded to me by my corporate tax adviser when questioning me on why I was holding the ETF ALMP the limited partnership fund that is listed on your website. I was unaware of the K1 forms that will most likely be required to be filed and may well outweigh the benefit of the diversification one is in hopes of achieving it. I thought you might want to share this for those who are interested in following some of your model portfolios. I certainly was unaware of this. Commodities are hot, but exchange-traded funds and other vehicles that hold them are causing massive tax headaches for investors. Just ask Darren Neuschwander, an accountant in Robertsdale, Ala., with high-net-worth clients around the country. In April Mr. Neuschwander billed one wealthy executive $3,500 to prepare his tax return—triple the tab from the year before. Mr. Neuschwander explained why to his shocked client: He had to account for investments in 30 ETFs, up from five the year before. Even though the executive lives in a state with no income tax, he had to file returns in half a dozen other states for the first time. The client said, "If my broker had told me about this, I probably wouldn't have gotten in." This is the dark side of investors' current rush into the trendiest investment strategy around: exchange-traded funds and other hot "alternative investments" such as exchange-traded notes and master limited partnerships, specializing in commodities like oil, currencies and gold. Collectively, the products fall under a new umbrella called "exchange-traded products." There isn't any doubt about investors' appetite for them: According to data compiled by analyst Deborah Fuhr of BlackRock Inc., which owns ETF giant iShares, ETFs specializing in commodities, currencies and other alternative assets took in $38 billion in new money from investors in 2009, $14 billion last year and another $7 billion so far in 2011. Over the same period, more than $75 billion flowed out of U.S. stock mutual funds. The largest commodity exchange-traded fund, SPDR Gold Shares (GLD), holds $59 billion, and by the end of May there were 205 commodity-related ETFs, up from 158 in December 2010. It is easy to see why investors are enamored. Still rattled by 2008's slaughter of conventional stocks and mutual funds but hungry for performance and yield, many have turned to commodities and currencies to hedge against the risks of a rising cost of living and falling dollar. ETFs can be a cheaper and easier way to invest in commodities than traditional methods such as futures or options. They trade throughout the day and you can see, in real time, what they own. Most don't have the risk of leverage, or borrowed money, that can wipe out a position if markets move against you. But they also carry potential tax traps. Among them: soaring tax preparation bills, odd tax rates, unexpected filings and tax on some assets in tax-sheltered individual retirement accounts (see "What to ask before buying"). That is ironic, since ETFs have long been praised for extraordinary tax efficiency; SPDR S&P 500 (SPY), the oldest ETF, hasn't distributed a capital gain since 1996, three years after it was launched. Even though ETFs trade like stocks and provide diversification like a fund, they often are structured very differently from the stocks and mutual funds many investors grew up with. Mutual funds generally aren't allowed to hold commodities directly, so the firms offering ETFs have turned to less familiar vehicles, such as partnerships, trusts or corporations. What to ask before buying an ETF If you don't want to wreak havoc on your tax returns, start with these useful questions. Extreme tax frustration Commodity ETFs can wreak havoc on your tax bill. Here's what you need to know. SPDR Gold Shares, for example, holds gold bullion in a "grantor trust." As such, profits and losses aren't claimed by the trust but "flow through" to holders and are taxed at their income-tax rates. There is a big difference at tax time: While holders of gold stocks in a mutual fund would pay tax on long-term capital gains (those held longer than a year) of 15%, long-term gains for Gold Shares holders are taxed at 28% because physical gold is a "collectible." Tax advisers and preparers are worried. "Most investors in these products have no grasp of what they're getting into," says Robert Gordon, head of Twenty-First Securities Corp. in New York. "I doubt if the brokers selling Alerian MLP ETF [a basket of energy firms] are explaining that it is a corporation that owns parts of many partnerships that own oil assets and owes an extra layer of taxes." Confused investors probably won't find much individual help from sponsors on thorny issues like having to file returns in multiple states or the fine points of mark-to-market rules for funds holding futures. Although Uncle Sam is phasing in rules requiring brokers to calculate "cost basis" for investors, they often don't apply to commodity ETFs. That is why paying your tax preparer to sort it out can cost so much. Here is just one example: Many ETFs are organized as partnerships for regulatory reasons, and they issue an annual K-1 tax report to each investor. A K-1 is like the 1099 for your mutual fund, but much longer and far more complex. CPAs interviewed for this article said each K-1 from an ETF takes up to an hour to put into a tax return, often at rates north of $150 an hour. That is why Mr. Neuschwander's tax-prep bill for his client with 30 ETFs was so large. At least the return was correct. K-1 tax information may be spread over many pages—unlike a simple 1099— confounding many do-it-yourselfers and even some professionals. Mr. Neuschwander also caught a mistake this year involving ETF K-1 information on a return prepared by another professional that missed a $20,000 deduction. ETF tax complications have become so notorious, says Chief Investment Officer William Koehler of ETF Portfolio Partners Inc. in Leawood, Kan., that some investors are insisting on selling funds generating K-1 forms even if they made money and want to hold the same underlying assets. Instead they are asking for ETFs that don't generate tax headaches. Mr. Koehler and his partners have a nickname for these clients: "K-1 and done." For investors in commodity ETFs, tax surprises can dent or even erase the gains you thought you got. With these new products, the old adage "know what you own" may not be enough. You also need to know what you'll owe. Copyright © 2011 Dow Jones & Company, Inc. All Rights Reserved. Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. 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