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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: energyplay who wrote (170792)	12/12/2008 8:36:39 AM
From: Sr K	Respond to of 306849

biz.yahoo.com Short ETFs May Pose Huge Tax-Liability Thursday December 11, 3:15 pm ET By ETFguide.com SAN DIEGO (ETFguide.com) - Talk about a performance drag. One short ETF dropped nearly 87% from Tuesday December 9th to Wednesday December 10th. Since we are talking about a short ETF, this drop was obviously not due to a huge spike in the market (the markets actually closed down on Tuesday). Short ETFs are designed to provide inverse or opposite performance to their index benchmark. Believe it or not, this drop was due to a capital gains distribution. The good news is; if you owned this inverse ETF you did not actually lose 87%. The bad news is; you had to report the 87% as ordinary income. This means, if you had $10,000 invested in this short ETF, Rydex would send you a check for $8,661 while the underlying ETF, the Rydex Inverse 2x Select Sector Energy ETF (NYSEarca: REC - News) lost 86.61% of its value. The $8,611 would have to be declared and taxed as ordinary income. If you happened to own REC in a tax-deferred account like an IRA or ROTH IRA, you don't have to worry about the tax. Was this the only fund to be hit by a capital gains distribution? REC was the ETF hit worst but not the only one. Below is a list of other Rydex index funds: Rydex Inverse 2x S&P Select Sector Energy, NYSEarca: REC, 86.61% capital gains Rydex Inverse 2x S&P Select Sector Technology, NYSEarca: RTW, 59.46% capital gains Rydex Inverse 2x S&P Select Sector Financial, NYSEarca: RFN, 49.67% capital gains Rydex Inverse 2x MidCap 400, NYSEarca: RMS, 31.97% capital gains Rydex Inverse 2x S&P Select Sector HealthCare, NYSEarca: RHO, 29.06% Capital gains Rydex Inverse 2x 500, NYSEarca: RSW, 13.22% capital gains Rydex Inverse 2x Russell 2000, NYSEarca: RRZ, 11.98% capital gains Will ProShares announce capital gains distributions as well? ProShares has not yet announced the scope of any capital gains distributions. Last year's ex-dividend date for ProShares was December 20th, so you still have some time to act. Capital gains distributions are distinctly binary. This means any shareholder who owns the declaring fund in question at the close of the ex-dividend date will be on the hook to receive the full distribution. It does not matter if you bought the ETF a day or several months ago. On the flip side, if you sell the ETF in question before the ex-dividend date, you will not be responsible for any capital gain distributions regardless of how long you've held the fund. How can this happen? Exchange traded funds have a sterling reputation for tax-efficiency. Many ETF families distribute minimal annual gains, if any at all. Most of the taxes are absorbed by institutional investors who redeem the underlying securities of the fund often for arbitrage profits. Shares with a lower tax basis are redeemed first leaving the individual ETF investor with minimal tax liabilities. Since underlying securities of inverse ETFs are options, futures contracts and swaps rather than individual stocks, the redemption process does not always work as smoothly. If a short ETF is redeemed, the fund company has to sell some of the underlying options and swaps in order to raise cash. REC's situation was further complicated by the large spike and subsequent drop of oil prices and energy companies along with a redemption that depleted half of the fund's assets. Small ETFs tend to get stuck with more tax distributions than larger funds. As of today, REC has less than $5 million under management. One could stand to reason that the tax-distribution for popular ProShares such as the ProShares UltraShort Financial (NYSEarca: SKF - News), ProShares UltraShort Real Estate (NYSEarca: SRS - News) and ProShares S&P 500 (NYSEarca: SDS - News) will not nearly be as significant as for REC. Inverse or short ETFs have given investors the opportunity to benefit from down markets with a simple brokerage account. Shorting the market was previously reserved for sophisticated investors and has been brought from Wall Street to Main Street by creative ETF providers such as Rydex and ProShares. Short ETFs have been a great tool to hedge against the losses suffered by the S&P 500 (AMEX: SPY - News) or Dow Jones (AMEX: DIA - News). Kevin Farragher, business manager at Rydex is confident to provide a more tax-friendly product in the future as their ETFs gain traction in the market place.