Exchange traded funds (ETFs) have been touted as investments that leave a small tax print come tax season, but that doesn’t mean all ETFs are taxed the same. Investors should be aware that “alternative assets” may incur different tax treatments as compared to most equity-based ETFs.
ETFs resemble mutual funds but are traded on a stock exchange, and the way the ETFs are created allows them to by and large avoid distributing taxable capital gains, which minimizes costs, writes Jason Zweig for The Wall Street Journal. [5 Things to Know About ETFs and Taxes.]
ETFs are tax-efficient as a result of the creation/redemption process which allows an investor to pay most of his or her capital gains upon final sale of the investment, according to Yahoo! Finance. Generally, an investor is affected by their marginal tax rate, the return on the investment and how long the investment is held. According to the IRS, the exchange of identical items do not trigger capital gains, which is good news for ETFs since they trade equivalent certificates, or “in-kind” trades.
Currency and commodity ETFs, on the other hand, are taxed differently since they act more like trusts or limited partnerships that pass income and gains to other investors. Analyst Mariana Bush of Wells Fargo Advisors tallies six different ways commodity ETFs may be taxed and eight different ways for currency ETFs. Here are some of the different ways ETFs may be treated. [ETFs and Taxes: It’s Not Just a Once-a-Year Thing.]
- Income from currencies or physical commodities may be taxed on other factors like money-market instruments, forward contracts, swap agreements, futures contracts or other derivatives. This compares to the stock or mutual fund investor who only pays 15% on qualified dividends and long-term capital gains.
- Additionally, commodity and currency ETFs may be taxed at a blend of short- and long-term capital-gains rates. Not to mention mark-to-market gains on funds held longer than 30 days after selling.
- Gold and other physically-backed commodity ETFs are also treated as collectibles, which the IRS would charge a 28% capital gains.
- Currency exchange traded notes (ETNs) as offered by iPath accrue income as currencies appreciate or depreciate against the dollar, which leads to an annual tax treatment.
- ETFs that are organized as partnerships or trusts require investors to file K-1 forms, which may increase tax-preparation bills. [More on the K-1 Form.]
For more information on ETFs and taxes, visit our taxes category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.