Exchange traded funds (ETFs) are often touted as a tax-efficient vehicle (that’s true, of course). But every year, a small percentage of them kick off capital gains. Here’s how you can deal.
Before you start the work of reducing taxes, you’ve got to understand the tax rules that apply to ETFs.
Hans Wagner for Forbes reports that the general rules are:
- If an ETF is held for more than a year, it gets the long-term gain treatment. If held for less than a year, the short-term treatment applies.
- When an ETF is sold, it triggers a taxable event.
If you’re looking at a capital loss, consider tax-loss harvesting. This entails selling a current ETF and purchasing a similar one with exposure to the same asset class, taking a loss on the original ETF for tax purposes. [It’s That Time Again: ETFs and Taxes.]
The tax treatment described above really only applies to equity ETFs. Venture into currencies, commodities and dividends, and some differences begin to appear:
- If an ETF owns a stock that pays a dividend, that dividend is passed on to the ETF’s shareholders. The investor may then owe taxes on the dividend.
- 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, on which the IRS would charge at 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 – commodity ETFs, typically – require investors to file K-1 forms, which may increase tax-preparation bills. [More on the K-1 Form.]
This article is simply informational; many investors may not know that ETFs can be subjected to different tax treatment, depending on a wide variety of factors. If you have more specific questions, please consult your tax professional for guidance that relates to your unique situation.
Tisha Guerrero 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.