How To Ditch K-1s? Let Me Count The Ways
|How Are Commodity ETFs Taxed?|
|40% of Gains||60% of Gains|
|Commodity Pool||Up to 39.6%||20%|
|Short-Term Rate||Long-Term Rate|
|ETNs||Up to 39.6%||20%|
|Grantor Trusts||Up to 39.6%||28%|
|Equities ETFs||Up to 39.6%||20%|
|"No K-1" Funds||Up to 39.6%||20%|
Commodity investors looking to avoid K-1s and the ETFs that issue them have a wealth of options, including:
The vast majority of commodity ETPs—108 of 170—are in fact ETNs. ETNs are unsecured debt instruments designed to track the returns of a given index; as such, they hold no underlying assets.
ETNs don't issue K-1s, but they do carry the credit risk associated with the issuing bank. If an ETN's issuing bank goes belly-up, then investors are out of luck. It doesn't happen often, but as Lehman Brothers investors can tell you, it isn't impossible.
More likely is the risk that ETNs will close to creations, generating significant premiums and discounts to net asset value. Also, many ETNs may be called, or redeemed, at any time, which could mean you lose some or all of your invested money.
Many physically backed metals ETFs opt for the grantor trust structure. Unlike other ETPs, whose portfolios may change day to day, grantor trusts are required to hold a fixed portfolio, making them well-suited for vaulted, nondecaying commodities like gold or silver.
Though grantor trusts avoid the K-1 headache, they do carry higher tax rates in both the short and long term, than commodity pools. Investors are taxed as if they directly owned the underlying metal, which means a 28% long-term capital gains rate instead of 20%, like ETNs or open-ended funds. Short-term capital gains, meanwhile, are taxed as ordinary income.
Some investors forgo the commodities themselves and instead invest in their producers, like oil exploratory firms or gold miners. Taxwise, producers ETFs act like any other open-ended fund, issuing 1099s and carrying a 20% long-term, max 39.6% short-term capital gains rate.
The complicating factor with equities ETFs, however, is that commodities producers sometimes—but not always—correlate more closely to the stock market than to the underlying associated commodities. For investors who turn to commodities for their portfolio diversification potential, having two assets that move in tandem may not be what they bargained for.
Open-Ended ‘No K-1’ ETFs
Still, other commodity ETFs, often advertised as "no K-1" funds, invest in futures but use a special workaround to avoid issuing K-1s. Currently, there are 12 "no K-1" ETFs:
|'No K-1' Commodity ETFs|
|PDBC||PowerShares Optimum Yield Diversified Commodity Strategy No K-1 Portfolio||0.59%||$1,110|
|COMT||iShares Commodities Select Strategy ETF||0.48%||$353.14|
|FTGC||First Trust Global Tactical Commodity Strategy Fund||0.95%||$207.87|
|BCI||ETFS Bloomberg All Commodity Strategy K-1 Free ETF||0.29%||$151.53|
|COM||Direxion Auspice Broad Commodity Strategy ETF||0.70%||$45.03|
|COMB||GraniteShares Bloomberg Commodity Broad Strategy No K-1 ETF||0.25%||$24.86|
|RCOM||Elkhorn Fundamental Commodity Strategy ETF||0.75%||$12.60|
|COMG||GraniteShares S&P GSCI Commodity Broad Strategy No K-1 ETF||0.35%||$8.30|
|OILK||ProShares K-1 Free Crude Oil Strategy ETF||0.65%||$6.59|
|BCD||ETFS Bloomberg All Commodity Longer Dated K-1 Free Strategy ETF||0.29%||$6.57|
|BEF||ETFS Bloomberg Energy Commodity Longer Dated Strategy K-1 Free ETF||0.39%||$3.80|
|DWAC||Elkhorn Commodity Rotation Strategy ETF||0.99%||$2.50|
Sources: ETF.com, FactSet. Data as of March 17, 2018.
Some portion of the portfolio—typically 25% or less—is held in a subsidiary based in the Cayman Islands. This portion tracks the relevant futures index and provides the fund's notional value. (The 25% cap allows the ETF to still structure itself as a '40 Act fund.) The remaining 75%, meanwhile, is held in high-quality U.S. debt securities, essentially functioning like a collateral portion of a futures investment.
For buy-and-hold investors, these funds blend the best of both worlds: They offer the exposure to futures prices, like commodity pools, but they're taxed like any other open-ended fund, with a 20% long-term cap gains rate and a 39.6% short-term gains rate. The only catch is that you have to be comfortable with the totally-not-a-tax-dodge way in which these funds are structured.