This could be the year that some exchange traded fund (ETF) investors face capital gain distributions, as there are reasons to expect a tougher year than anticipated. Capital gains distributions for all funds, not just ETFs, are expected to increase following the five-year bull run in which mutual funds steadily appreciated, reports Ian Salisbury for The Wall Street Journal.

ETFs resemble mutual funds, yet trade on an exchange like a stock, and have been sold on the notion that they are good protection from capital gains distributions. Because of the creation and redemption of shares, an ETF can eliminate many of the capital gains. For 2007, a few ETFs are set to hand out a tax bill to shareholders, but their percentages will be small compared to mutual funds.

Barclays estimates 6 of their ETFs will have capital gains distributions; State Street expects 23 of their ETFs and Vanguard said none of its ETFs will have gains. Some ETFs with gains include:

• SPDR Dow Jones Wilshire Mid-Cap Growth ETF (EMG) long and short term gains equal to 6.2% of assets.
• HealthShares Cardiology Devices ETF (HHE) short term gains of about 3.7% of assets.

It’s important to remember that ETFs are tax efficient, but they are not tax-free.