ETFs and tax-efficiency (2024)

FAQs

ETFs and tax-efficiency? ›

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.

Thanks to the tax treatment of in-kind redemptions, ETFs typically record no gains at all. That means the tax hit from winning stock bets is postponed until the investor sells the ETF, a perk holders of mutual funds, hedge funds and individual brokerage accounts don't typically enjoy.

As a result, both ETFs have a very low expense ratio of 0.03% and a minimum investment of $1.00. Since VTI and VOO are both ETFs, they have the same trading and liquidity, tax efficiency, and tax-loss harvesting rules.

Consider investing in a tax-efficient REIT ETF: Some REIT etfs are more tax-efficient than others. For example, some ETFs have a lower turnover rate, which means they buy and sell assets less frequently, resulting in fewer taxable events.

Tax-loss harvesting can be a great strategy to lower tax exposure but traders must be sure to avoid wash sales. You can't replace a security that you've sold at a loss by purchasing one that's substantially identical from 30 days before the sale until 30 days after it's complete.

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

An ETF gives you an affordable way to follow the stock market or a particular part of the market. While REITs provide the stability and robust returns of real estate.

If you're investing in a taxable brokerage account, you may be able to squeeze out a bit more tax efficiency from an ETF than an index fund. However, index funds are still very tax-efficient, so the difference is negligible. Don't sell an index fund just to buy the equivalent ETF.

What is the downfall of ETF? ›

The greatest risk for investors is market risk. If the underlying index that an ETF tracks drops in value by 30% due to unfavorable market price movements, the value of the ETF will drop as well.

Market risk

The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.

Yes, an inverse ETF can reach zero, particularly over long periods. Market volatility, compounding effects, and fund management concerns can exacerbate losses. To successfully manage possible risks, investors should be aware of the short-term nature of these securities and carefully monitor their holdings.

For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners. If you hold the ETF for less than a year, you'll be taxed at the ordinary income rate.

Tax loss rules

These capital losses can be used to offset capital gains (from any investments, not just ETFs) and up to $3,000 of ordinary income ($1,500 for married persons filing separately). Capital losses in excess of these limits can be carried forward and used in future years.

Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.

Fixed-income funds that distribute income that is not subject to taxation at the federal, state, and sometimes local levels.