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investor clinic

I have a question about calculating the yields of real estate investment trusts. Many REITs distribute significant amounts of return of capital. It has never made sense to me to include getting my own money back when calculating my yield. Do posted yields need to be adjusted by deducting the ROC to get a more realistic idea of what one is receiving?

Return of capital doesn’t necessarily mean you are “getting your own money back.” In general, ROC is defined as the portion of a distribution that does not consist of dividends, interest, realized capital gains or other income. In some cases – for example, a high-yielding mutual fund that distributes so much ROC that its net asset value erodes over time – you are indeed getting paid with a portion of your original capital.

But with REITs, it’s not that simple. ROC typically arises when a REIT’s distributions exceed its taxable income. This isn’t necessarily a problem, however, because income is affected by accounting items, such as depreciation, that don’t reduce cash available for distributions. In other words, when you receive ROC, you are getting cash generated by the business, not some sleight-of-hand trick by the REIT.

For investors, ROC has one big advantage: It is not taxed immediately. Rather, ROC is subtracted from the investor’s adjusted cost base, which gives rise to a larger capital gain – or smaller capital loss – when the units are eventually sold. For REITs that distribute large amounts of ROC, it can significantly reduce the tax burden in non-registered accounts.

Interested in a particular REIT? Most REIT websites provide a detailed annual breakdown of the tax characteristics of their distributions. In addition to distributing ROC, REITs typically pay out capital gains (50 per cent of which is taxable), other income (which is fully taxable) and in some cases, dividends (which benefit from the dividend tax credit).

One final note: When assessing their operating performance, many REITs focus on real estate cash-flow measures, such as funds from operations (FFO) and the more stringent adjusted funds from operations (AFFO). These measures are also useful for determining a REIT’s payout ratio and assessing the sustainability of its distributions.

Last fall you wrote a favourable column about Fortis Inc. (FTS). Has your enthusiasm changed now that bond yields are starting to rise?

There’s no question that rising rates pose a headwind for utilities and other companies that a) carry a lot of debt, and b) generate steady, bond-like cash flows. Predictably, Fortis’s share price has taken a hit, falling about 10 per cent since October.

The flipside of that weakness, however, is that Fortis’s yield has recently risen to more than 4 per cent for the first time in nearly a year. What’s more, the company has targeted dividend growth averaging 6 per cent annually through 2025, so – assuming it makes good on that pledge – the yield is even more attractive.

As a buy-and-hold dividend investor, I don’t try to time interest rates or other factors that are beyond a company’s control. I prefer to just collect my rising dividends, and if the share price weakens materially, I would consider buying more.

Most analysts are positive on Fortis, citing its steady, regulated returns and its five-year capital spending plan of $19.6-billion through 2025 that will drive both its rate base – the value of assets on which a utility is permitted to earn a regulated rate of return – and its earnings higher.

Fortis also stands to profit from decarbonization and the transition to renewable energy. “We regard the current valuation as attractive and believe the company’s steady rate base and [earnings-per-share] growth will be augmented by opportunities in renewable generation and transmission projects going forward,” David Quezada, an analyst with Raymond James, said in a note following Fortis’s fourth-quarter results in February.

I live in Canada and I was holding shares of United Technologies Corp., which in April, 2020, merged with Raytheon Corp. to create a new company called Raytheon Technologies Corp. As part of the transaction, United Technologies spun off two of its businesses, Otis Corp. and Carrier Corp., to shareholders. On my T5 slip from my broker, I have significant tax exposure because of this “stock dividend.” My question is: Since I have not sold my Carrier and Otis shares, can I defer the gain to a future time when I do sell them?

If you go to the “Investors” section of Raytheon Technologies’ website and click on “Merger Resources,” you’ll see a link to “Canadian shareowners’ tax information on the Carrier and Otis spin-offs.” This will take you to a Canada Revenue Agency web page that lists the Carrier and Otis spin-offs as being eligible for tax deferral.

That’s the good news. The bad news is that if you make this election, there is some work involved to get that tax deferral. You’ll need to attach a detailed letter to your tax return (which, according to the CRA, can’t be filed electronically in such cases). You will also need to calculate the adjusted cost base of your Carrier and Otis shares to determine your capital gain when you eventually sell. For more information – and some sample ACB calculations – google “CRA foreign spin-offs.” You may want to seek the advice of an accountant to help you through the process.

E-mail your questions to I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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