3 ETF Tax Tips While There’s Still Time

November 06, 2014

You’ve got eight weeks left to get smart with your mutual funds and ETFs.

It’s that time of year. The leaves are off the trees in New England, the election is over and it’s time for mutual funds and ETFs to start announcing their year-end distributions. Here are a few key tips to keep in mind that might save you some money come April.

Avoid Traps

1. Don’t buy into a mutual fund before year-end! Actively managed funds in particular are going to be hit with some big distributions for capital gains. This year has been a perfect storm: We had a huge run-up in stocks, decent performance in bonds and then a pullback. Classic investor behavior suggests investors piled in on the way up, and sold as things got worse.

This leads to selling of positions inside the mutual funds, and that leads to capital gains. In fact, that’s exactly the flow pattern we’ve seen in traditional mutual funds this year according to the Investment Company Institute, the mutual fund industry trade group.

Remember, those capital gains distributions get spread equally to anyone holding shares on the distribution date, whether you had the privilege of being along for the good times or not.

Sell Judiciously

2. If you’re already in, consider your gains carefully. It’s entirely possible that based on poor timing, you could be sitting on a loss even though your mutual fund is going to hit you with a taxable distribution. If you’re sitting on a loss, consider selling before distributions are announced. Even if you’re sitting on a gain, if that gain is modest and has been for less than the full year, you might still be better off paying the capital gain on your own basis than getting the pending distribution.

Which brings me to …

Don’t Fear The Reaper

3. Harvest those losses!

Most investors are likely to have some taxable gains this year—even ETF investors. The magical tax-lot-washing of ETFs will still save investors a ton of money this year, but it’s not perfect. If there haven’t been redemptions, funds that essentially have to sell stocks or bonds due to rebalancing or bonds maturing will have some level of capital gains to distribute. Your best defense against those capital gains bills is to lock in some capital losses.

Internal Revenue Service rules let you sell something at a loss and replace the position with another security. You can’t buy the exact same security back, and the common advice from tax attorneys is you can’t just swap two funds tracking the exact same index.

 

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