Taxable vs. tax-free accounts: where do you hold your investments?

First, let’s just assume that you have two investment accounts: a personal investment account and a tax-advantaged (tax free) IRA

Hold in a taxable account:

Commodity funds: If they invest in the actual commodities they won’t pay significant distributions/dividends like natural resource / commodity funds that buy equities of companies whose operations are based on the actual commodities. Since there are low distributions, and presumably you’re holding commodities as a core investment holding for asset allocation purposes and as a hedge against inflation, you probably plan on keeping your commodity holdings for longer than one year. If so, that means your sales will be classified as long-term capital gains, so the tax hit is only about 15%

Biotechnology funds: Biotech companies have little or no dividends, in general, so there’s little to no current income. Assuming again that this is a long-term holding, you probably hold it for over a year, which again means the long-term capital gains tax hit is only about 15%.

Covered call funds: Since covered call funds have long-equity exposure, I prefer to hold them in my taxable account because, should they decline, I can take tax losses against other long-equity positions b/c that’s where I hold single stock and other equity positions (like emerging market equity ETFs). I try to hold all my long-equity positions over one year to get long-term capital gains tax treatment, but if you’re a short-term trader then you should probably do so in your tax-free account to avoid the higher short-term tax impact. Keep in mind that you can’t take tax losses on your investments in a tax free account, so if you do lose money you can’t sell your losers to offset taxes on your winners.

Long/short equity funds: I hold them in either my taxable or tax free accounts, but at the moment I prefer to hold them in my taxable account because they don’t really distribute investment gains or dividends with frequency or meaningful size. If you have a long/short equity fund in your tax free account, and the tax free account allows you to sell after time without realizing any capital gains taxes at all, then it makes sense to keep it there if you’re willing to hold on for a long time horizon.

Private equity ETFs: They distribute some dividends, depending on the holdings of the ETF (some PE firms that are listed pay dividends and some don’t). I personally look at the PE sector as a unique investment at the moment because of their unusual volatility over the last two years or so, so I don’t think I’ll sit on my private equity ETF holdings indefinitely, so I keep it in my taxable account.

Buyback / repurchase ETFs: Companies that have large repurchases have opted to allocate their capital towards returning it to investors and doing so via buyback and not dividend, hence the dividend income is pretty small. As a result, it’s basically a capital appreciation investment, and since I hold that type of investment longer than a year to qualify for long-term capital gains tax rates, I keep it in my taxable account.

MUNICIPAL BONDS / MUNI BOND FUNDS: THESE SHOULD ALWAYS BE HELD IN YOUR TAXABLE ACCOUNT BECAUSE YOU DON’T PAY TAXES ON THEM ALREADY. That’s the point of holding munis, so there’s little logic in holding a tax free investment in a tax free account, because it’s redundant.

Hold in a tax-free account:

Real estate funds: Most real estate funds generate significant current income via dividends, and REIT dividends actually do NOT qualify for the lower qualified dividend tax rate. Additionally, most real estate funds have high turnover (though not all do) so you avoid their short-term capital gains exposure by holding it in a tax-free account.

Emerging market debt: They pay out non-qualified interest income frequently and a good portion of their capital gains tend to be short-term, so I hold them in my tax free account.

Merger arbitrage funds: They have VERY high turnover because most deals get closed in less than a year, so they have significant short term capital gains issues, hence I hold it in a tax free account.

Closed end fund (CEF) fund of funds (FoF) CEF FoF: They pay out a ton of distributions that usually do not qualify for lower dividend tax rates.

Currency funds: Their distributions need to be shielded from taxes, but not all pay significant or frequent distributions, so you need to look at the history of the actual funds themselves before you decide.

Floating-rate /variable rate debt funds: The vast majority of them invest in senior bank loans that are not tax exempt, so you try to shield the taxable income by keeping them in a tax free account.