Following my investment in Urbana (URB) (which I recently exited simply because I had better places for the capital), I had been investigating Capital Southwest (CSWC). Capital Southwest, like Urbana, is a closed end fund that trades at a significant discount to book value.
However, I think the two of them missed one thing: taxes. In my due diligence, I stumbled upon this article over at VIC. The basics of the tax situation is this: most closed end funds distribute capital gains to their shareholders, who then must pay taxes at their capital gains rate. In contrast, CSWC pays taxes at the full corporate rate. Shareholders can then do one of two things. 1) Taxable shareholders can claim the difference between the rate CSWC paid and their own rate as a tax shield. 2) Non-taxable shareholders can request a full tax refund from the IRS.
Please read the VIC article for more details (and, of course, consult a tax advisor! See page 10 of their 10-k for more info), but that makes CSWC really, really interesting when bought through an IRA or other non-taxable account. Remember, CSWC has some fully owned companies with huge capital appreciation on them. When CSWC sells them, they’re going to pay a huge tax bill. If you own them through an IRA account, you could have your share of that tax bill paid to you in cash. Since you’re buying them at ~2/3 of book, the cash from the tax could represent a huge return on capital for your investment (plus, you’d still have the investment in CSWC)
Again, please read the VIC post and the two posts linked above for more information. Definitely an interesting idea, especially for someone looking for a “buy and forget” policy in a non-taxable account.
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