Leveraged Income Experiment

George the original one · Sun Apr 10, 2011 4:43 pm

@DVDend - Line 14, Schedule A. Form 4952 may or may not be needed. For more details, see publication 550.
The interest is not treated like a business expense, so you don't get to remove it off the top. Rather it's treated like mortgage interest, where you get back 25%/28%/33%/35% (or whatever your marginal rate is).
When you think about it, it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?
[edit] NOTE: If you're thinking about buying tax-free income on margin, that interest is NOT deductible. You'll want to establish a separate non-margin account for such transactions so that your records aren't muddled.

DVDend · Post by **DVDend** » Mon Apr 11, 2011 5:30 pm

George TOO: Thanks for the reply. I was hoping that I could deduct the interest expense from investment income. Something "unofficial" on the web made me think that interest expense could offset at least short term capital gains. I guess this is wrong. Better to go to the source and read the IRS publications.

Post by **jacob** » Mon Apr 11, 2011 6:31 pm

"When you think about it, it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?"
I can answer that one.
Mortgage => Steady income => More tax income.
A government would be rational to give incentives to commit to any kind of indentured work that it can simultaneously tax.

Chris · Post by **Chris** » Mon Apr 11, 2011 7:48 pm

"it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?"
A possible answer: it's not that the tax code was set to /allow/ it, but hasn't yet /disallowed/ it.
If you look at old 1040s, you'll find that all personal interest was deductible. Over the years, this has become more restrictive.

George the original one · Mon Apr 11, 2011 9:47 pm

A perspective on BDCs and mortgage REITs:

http://seekingalpha.com/article/262972- ... gage-reits
To replace the UHT income, I've bought 200 ARCC and 200 TICC. For regular stocks, I'd purchase later, closer to their dividend declaration date to minimize margin interest expense. However, BDCs and mortgage REITs tend to be substantially cheaper in the few days after they're ex-dividend and gradually rise in price as you get closer to the next dividend time.
Next week I beleive my deposit will be credited, so I'm planning the next purchase. MAIN is one of the candidates, a BDC that pays monthly dividends.

George the original one · Wed May 04, 2011 3:24 am

April results are now posted.
A sale, a deposit, and several purchases meant fees ate into income. The purchases won't add any income until this month, so the net yield on cost for this month is lower due to the deposit.
Broke my rule of buying only in lots of 100 shares, since there was only enough margin to buy 50 NRGY. My justification is that a bump in the income was more worthwhile.
OHI delivered some bad news late last week when 4 of their care facilities were closed by the state of Mass. The market punished the REIT's price by 6+%, which is pretty severe considering the properties represent less than 1.5% of their invested capital and the situation was already cited as a potential risk in the annual report.

George the original one · Wed May 11, 2011 7:12 pm

I'm being punished today for the NRGY choice. They posted quarterly results full of one-time charges (they _better_ be one-time charges!) and the market is beating the price down. Looking at the price chart since last week, it's easy to see that some people had a good idea of what would be in the quarterly report.
Assuming that the charges are one-time, then NRGY is a better deal now. Time to examine the quarterly report more thoroughly and possibly make another deposit to the account so I can finish out the 100 share lot. Or sell, if there are demons in the report.

Chris · Post by **Chris** » Wed May 11, 2011 8:17 pm

NRGY holder here. I haven't yet analyzed the results closely yet, but APU also had a bad quarter, based on warm weather in the South. Basically, winter "ended early" so propane deliveries were down. Looking at NRGY's propane distribution map, the majority of their footprint is in the southeastern US.
The quarter was bad, but also the div-ex date was last week, so that may be a factor for at least some of the selling.

B · Post by B » Thu May 19, 2011 6:56 am

I am still learning about investing, but couldn't you sell covered calls on these positions for some extra income?

George the original one · Thu May 19, 2011 4:02 pm

Yes, covered calls could be sold. However, if the stock is called, the income ends. Plus options are a zero sum game.
You also have the question of liquidity. If you have the security locked up for the option, then you can't otherwise sell it if the need arises. The options market is significantly smaller than the regular market, thus it can be difficult to find someone who will take the other side of the bet at a price you're comfortable with.
Arbitraging the difference in interest rates between the margin loan and the security's yield is not zero sum, doesn't force you to sell if you don't want to (unless there's a margin call), and liquidity is maintained.

George the original one · Tue Jun 07, 2011 1:49 am

May results are now posted (see link at the top of this thread), a little later than planned because IE9 didn't like Google docs.
I was also a little late getting a deposit mailed last month, so it will appear on the June statement.
As you may guess from the downturns in the major indexes, the market value of my experiment is down. Leveraging does indeed make these turns more volatile.
However, the income, the real purpose of this portfolio, is fattening up nicely.

George the original one · Mon Jul 04, 2011 5:58 pm

June results are now in the Google docs spreadsheet.

https://spreadsheets.google.com/ccc?key ... y=CMHbguoK#
$6,000 in deposits allowed me to fill out my desired positions (and subsequently increase income). Forward estimates suggest the average yield-on-cost to be about 13%.
On the down side, increasing the equity by 40% drops yield-on-cost for June to <5%.
There's an extra $10 fee in this month's statement. I don't understand why, it's just labeled "U.S. Security and Commodity Exchanges".

George the original one · Fri Jul 08, 2011 11:16 pm

For the second time this year, Mr. Market granted me excess liquidity, enough that I added another 100 TICC yesterday.
Average anticipated net income (excluding taxes... different people would have different tax rates) is now $220/mo for $18k invested.

George the original one · Thu Jul 14, 2011 4:03 pm

Reviewing total return for the past 6 months, the leveraged portfolio has done about the same as my regular portfolio. Not only that, but the ratio of capital gains to dividends is about the same. I suspect this is due to the fact that deposits into the leveraged portfolio are a greater percentage of the portfolio's value and the deposits take some time, up to 3 months, before subsequent dividend income is generated.
Looking forward, the leveraged portfolio should have significantly more dividends than the regular portfolio.

Sojourner7 · Post by **Sojourner7** » Thu Jul 14, 2011 10:42 pm

George, thanks for posting all this. I've been thinking about doing something like this for almost a year now but chickened out. 10k is a lot for me!
Keep up the good work!

George the original one · Sat Jul 16, 2011 5:09 pm

Yippee! OHI has announced their 2nd dividend increase this year (payable Aug 15) -- dividend is now up 8% since the beginning of the year.

Sojourner7 · Post by **Sojourner7** » Sun Jul 17, 2011 3:28 am

Hey George, that's good news.
Anyway, I thought of a question for you. In terms of taxes, is it possible to deduct interest paid for margin expense? I was speaking with someone about investments, and I mentioned that being leveraged in real estate is more tax friendly compared to stocks because you can deduct mortgage interest. They responded saying that you can deduct margin interest if you itemize deductions. Do you know if this is true?
Thanks,

S7

George the original one · Sun Jul 17, 2011 2:46 pm

Yes, margin interest is deductible. Line 14 on Schedule A.

Sojourner7 · Post by **Sojourner7** » Sun Jul 17, 2011 5:26 pm

I just realized that had been mentioned already in this thread. I must've been having too much hard apple cider!

Hoplite · Post by **Hoplite** » Thu Jul 21, 2011 7:37 pm

NRGY is getting punished again today, I think for a Citi downgrade from hold to sell. I don't own it, but read the last 10Q and didn't see the reasons for the pessimism (not that that means anything). I noticed that you filled in NRGY to 200 shrs--does the price change affect this one way or the other?
And I add my sincere thanks-this is a great experiment on the income side and much appreciated!