The Virtus InfraCap U.S. Preferred Stock ETF (PFFA) pays a distribution rate near 9.7%, but its tax efficiency is mediocre by conventional measures: distributions split unpredictably each year between qualified dividends, ordinary income, and return of capital, and the fund’s active trading and internal leverage push more income into the higher-taxed and deferred buckets than a passive preferred ETF would. Whether that matters to you depends on your bracket and, more than anything, the account you hold it in.
How PFFA’s Distributions Are Taxed
Every dollar PFFA pays lands in one of three tax categories, and each hits your return differently.
Qualified dividends from U.S. corporate preferreds qualify for long-term capital gains rates under IRC Section 1(h)(11), but only if two holding-period tests are met. You must hold the ETF shares for more than 60 days during the 121-day window centered on the ex-dividend date, and the fund itself must clear the same test on its underlying positions.1Legal Information Institute. 26 USC 1(h)(11) – Dividends Taxed as Net Capital Gain PFFA’s active trading can break that second test on some positions, converting what would have been qualified dividends into ordinary income.
For 2026, qualified dividends are taxed at 0% if your taxable income stays below $49,450 (single) or $98,900 (married filing jointly), 15% up to $545,500 (single) or $613,700 (joint), and 20% above.2Internal Revenue Service. Revenue Procedure 2025-32 Ordinary income is taxed at your marginal rate, reaching 37% for single filers above $640,600 or joint filers above $768,700.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 On the same dollar of income, that gap between 20% and 37% is the whole tax-efficiency story.
The final split shows up on your Form 1099-DIV. Estimated breakdowns appear during the year in Section 19(a) notices on the Virtus website.
Why Some of the Income Is Ordinary
PFFA holds traditional preferred shares alongside trust preferred securities. Trust preferreds are structured as debt issued through a trust, so the payments are classified as interest rather than dividends. That interest is ordinary income no matter how long you hold the fund. The manager’s allocation between the two types directly controls how much of your distribution can qualify for lower rates.
The Section 199A Slice From REIT Preferreds
Ordinary dividends from REIT-issued preferreds that flow through PFFA can qualify for the 20% deduction under Section 199A, effectively lowering the tax rate on that portion. Qualified dividend income from REITs does not qualify. You also need to hold the fund shares for at least 45 days to claim the deduction on those distributions. The eligible amount depends on the year’s REIT preferred allocation and is reported on your 1099-DIV.
Return of Capital and Your Cost Basis
A meaningful chunk of PFFA’s payout is often classified as return of capital, which happens when the fund pays out more than it earned in dividends and realized gains. It isn’t taxed as income in the year received. Instead, it reduces your cost basis under IRC Section 301(c)(2).4Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property
Buy PFFA at $20 and take $1.50 in return of capital over the year, and your adjusted basis drops to $18.50. No tax today. But when you sell, your gain is measured from $18.50, so you owe more in capital gains then. Return of capital is deferral, not elimination.
If your basis reaches zero after enough years of return-of-capital distributions, any further payments of that type are treated as gain from the sale of property and taxed in the year received.4Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property That’s a real possibility for long-term holders given PFFA’s yield. Track your adjusted basis yourself, since brokerages don’t always catch every reclassification.
Filing Timing
The Section 19(a) estimates during the year are just estimates. The 1099-DIV brings the final classification, and even that can be corrected. Most reclassifications hit between March and early April, sometimes later. File in early February on preliminary numbers and you may end up amending. For PFFA holders, waiting until early April is the pragmatic move.
How Leverage Shifts the Tax Character
PFFA borrows to amplify preferred exposure, targeting 20% to 30% leverage.5InfraCap. Virtus InfraCap U.S. Preferred Stock ETF That boosts the distribution rate but also creates interest expense the fund deducts against gross income before paying shareholders. Larger deductions mean less taxable income to distribute, which raises the share of your payout classified as return of capital.
When rates rise, borrowing costs climb, deductions grow, and more of the distribution shifts toward return of capital. When rates fall, more of it is currently taxable. The leverage makes PFFA’s tax character more sensitive to the rate cycle than an unleveraged preferred ETF, which isn’t necessarily bad for after-tax returns in the short run since return of capital is deferred, but it makes year-to-year planning harder. The fund’s total expense ratio of roughly 2.11% reflects those borrowing costs alongside management fees; you never pay them directly, but they reduce net income and shape what’s left to classify.
The 3.8% Net Investment Income Tax
Higher-income investors face an additional 3.8% surtax on net investment income under IRC Section 1411, which applies to both qualified dividends and ordinary distributions from PFFA. It kicks in when modified AGI exceeds $200,000 (single), $250,000 (joint), or $125,000 (married filing separately), and is assessed on the lesser of net investment income or the amount by which MAGI exceeds the threshold.6Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
Return-of-capital payments aren’t investment income in the year received, so they escape NIIT in the short term. The capital gain you eventually realize on the reduced basis is subject to NIIT if you’re still over the threshold then. For a top-bracket holder, the effective rate on qualified distributions reaches 23.8% (20% plus 3.8%), and ordinary distributions face up to 40.8% (37% plus 3.8%).
Where to Hold PFFA
The account choice matters as much as the fund choice.
Taxable Brokerage
Here you get the full complexity: basis adjustments from return of capital, watching for reclassifications, and paying tax on qualified and ordinary income each year. The qualified portion gets lower rates and return of capital defers tax, but every event flows through. This is where PFFA’s tax inefficiency shows up hardest against a plain index ETF.
Traditional IRA
Holding PFFA in a Traditional IRA eliminates the annual complexity. Distributions compound without taxable events and there’s no basis tracking. The trade-off: all withdrawals are ordinary income regardless of what the underlying distributions were.7Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts You lose the qualified dividend rate entirely.
Roth IRA
A Roth is arguably PFFA’s best home. Qualified withdrawals are tax-free, so the high yield compounds with no current or future tax drag, and the distinction between qualified, ordinary, and return-of-capital income becomes irrelevant. The trade-off is using limited Roth space on a high-expense fund.
UBTI Note for Tax-Exempt Accounts
PFFA is a regulated investment company under IRC Section 851.8Office of the Law Revision Counsel. 26 USC 851 – Definition of Regulated Investment Company That structure generally shields tax-exempt investors from unrelated business taxable income even though the fund uses leverage internally, because the debt-financed income rules apply at the fund level and aren’t passed through. A partnership or MLP structure could have produced UBTI for IRAs; the RIC structure avoids that.
Wash Sale Traps When Selling PFFA
Sell PFFA at a loss and repurchase the same fund within 30 days before or after, and the loss is disallowed under the wash sale rule.9Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities The disallowed loss typically gets added to the basis of the replacement shares, deferring the benefit rather than erasing it.
The gray zone is what counts as substantially identical. Buying a different preferred ETF with a meaningfully different index or strategy should not trigger a wash sale, though the IRS hasn’t published a bright-line test. Buying PFFA itself, or an ETF tracking the same index with the same methodology, clearly does.
One trap is expensive: sell PFFA at a loss in a taxable account, then buy it back inside an IRA within 30 days, and the loss is disallowed with no basis increase in the IRA. That loss is gone permanently, not deferred. Investors consolidating positions across account types get caught by this.
Inherited Shares and Step-Up in Basis
When PFFA shares pass to a beneficiary at death, the basis resets to fair market value on the date of death under IRC Section 1014.10Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent All the accumulated return-of-capital basis reductions vanish. Bought at $25, received $10 in return of capital reducing basis to $15, shares worth $22 at death: the beneficiary’s basis is $22. Years of deferred gains disappear.
That makes PFFA’s return-of-capital component useful for estate planning. Deferral that would otherwise turn into a larger gain at sale can become permanent tax avoidance when shares are held to death. If shares have fallen below the original purchase price, the basis steps down to market value, so the adjustment goes both directions.
The Bottom Line
PFFA is not a tax-efficient fund by conventional measures. Active turnover shortens holding periods on underlying positions, leverage costs push income toward return of capital in ways that follow the rate cycle, trust preferred holdings generate ordinary income, and the high distribution rate accelerates taxable events. Return of capital gives back some of that through deferral, keeping more cash in your hands today at the cost of a larger gain later. For lower-bracket investors or anyone holding the fund in a Roth IRA, the inefficiencies matter less. For top-bracket holders in taxable accounts facing 40.8% on ordinary distributions, the drag is real and worth quantifying before you buy.