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I'd handed my completed income taxes to the mailman, and was kicking back on my sofa with a beer to flip through that day's mail. I felt perfectly relaxed -- until I scanned a mailing from the U.S. Oil Fund (NYSE: USO ) . I dropped the beer onto my foot (ouch!) out of shock. Inside was a K-1 form, which showed income from straddles and contracts of about $2,200.
This would be fine, except that I had lost money on a quick trade of the oil fund. Why did this form say I had made money? Even worse, the mailman had disappeared down the road, along with what I realized was an incomplete IRS Form 1040.
Welcome to exchange-traded fund (ETF) investing for small-f fools. I wanted exposure to oil, but I jumped the gun with my choice. See, most ETFs behave like stocks or stock indices. However, the U.S. Oil Fund deals instead with oil futures contracts. If I'd been wearing my Fool cap, I'd have read that the name of the U.S. Oil Fund is, in fact, United States Oil Fund, LP, as in "Limited Partnership!" I should've expected a K-1. And that means I should've checked to see whether I might have income reported that I never actually received!
This represents just one of the many ETF traps out there. Did you know that capital gains on SPDR Gold Shares (NYSE: GLD ) are taxed at 28%, because gold is considered a collectible, even if you hold for a year? Profitable trades from currency ETFs, such as PowerShares DB U.S. Dollar Bullish (NYSE: UUP ) and Bearish (NYSE: UDN ) , get taxed as ordinary income, regardless of holding period. Commodity securities PowerShares DB Commodity Index Tracking Fund (NYSE: DBC ) , PowerShares DB Oil Fund (NYSE: DBO ) , PowerShares Gold Fund (NYSE: DGL ) also generate K-1's.
The point here? I didn't do my Foolish research. When it comes to any security, particularly an ETF or mutual fund, you must read through the prospectus. There may be hidden fees, different ways of treating dividends (Real Estate Investment Trust (REIT) dividends are often "non-qualified"), and different tax treatments for gains or, in my case, taxes due on a trading loss.
Lesson learned. Hopefully you can benefit from my mistake. Pay careful attention to what you are buying. You cannot just grab any old ETF and think it's, well, any old ETF.
So, if you'll excuse me, I have to redo my 1040 by adding in $2,200 of income I never received, so that I can be taxed on it. Sigh.
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