3 ETF Tax Tips While There’s Still Time

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

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Reviewed by: Dave Nadig
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Edited by: Dave Nadig

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.

 

But ETFs make it easy to find alternatives.

It can sometimes be tricky, however, to find the losses. The most likely candidate this year is the SPDR Gold Shares (GLD | A-100), the gold bullion ETF. GLD is down 5.45 percent this year. Assuming you bought it on Jan. 1, you could theoretically sell it and book that as a loss. Technically, as a collectible, some accountants would tell you that you could immediately rebuy yours shares and not trigger a wash-sale problem. You could simply book the losses and use them to offset gains of whatever time-bucket the holding period was.

A more conservative approach than just rebuying a bullion ETF is to replace the exposure with either a gold miners ETF like the Market Vectors Gold Miners ETF (GDX | B-71) or the PowerShares DB Gold ETF (DGL | C-57). Neither is perfect (one being equities, the other being futures), but they could tide you over for the 30 days to let the IRS’ wash-sale rule expire. The tax status of bullion ETFs is tricky, and this is definitely tax-accountant advice time.

Other widely held ETFs that are down for the year are the Vanguard FTSE Developed Market ETF (VEA | A-92) and the iShares MSCI EAFE ETF (EFA | A-92). If you’re down on either of those positions, consider selling one and buying the other. The funds track different indexes but provide extremely similar exposure, which means you can keep your portfolio effectively intact while avoiding the wash-sale rule.

You can do the same thing if you’re currently sitting on a loss in either the Energy Select Sector SPDR Fund (XLE | A-96) or the iShares U.S. Energy ETF (IYE | A-96). Both are down on the year, but both use slightly different indexes to go after similar exposures.

Many investors wait until it’s too late—after distribution season—to start making these portfolio moves.

Don’t be that guy.

 

Editor’s note: You can use our ETF finder to find ETFs with similar exposures. Just dig into the segment reports to see if there’s a fund that’s close—but not too close—to the one you’re selling. Also, don’t miss our Definitive Guide To 2014 ETF Taxation.


At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.

 

Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of etf.com. Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.