ETFs Made Easy: Capital Gains Tax

While most ETFs are taxed like stocks and bonds, there are exceptions.

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Reviewed by: Dave Nadig
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Edited by: Dave Nadig

While most ETFs are taxed like stocks and bonds, there are exceptions.

In this series, we answer the questions investors are afraid to ask. You can submit your questions to me at [email protected]. All correspondence will remain anonymous.

It’s the end of the year—the last time you can actually do anything about your taxes before the IRS comes knocking. ETFs can be an important tool in managing your investment taxes, but it’s important to understand what to expect when the forms start rolling in in January.

Plain-Vanilla ETFs

The most important thing to remember is that the vast majority of ETFs (1,368 out of 1,665!) are going to be handled just like any stock or mutual fund you might own. If you buy it for $10 and sell it for $20, you’ll owe capital gains tax on that $10 profit. If you held it for more than a year, you’ll get to use the lower long-term capital gains tax rate, just like you would for a stock or a mutual fund.

And just like a mutual fund, if the ETF had to do any buying or selling of securities over the course of the year, you might get a capital gains distribution – usually sometime in December. If you’re sitting on an ETF that’s trading at $10, they might give you a $1 capital gains distribution. That would reduce the value of the ETF to $9, but you’d have that $1 sitting back in your brokerage account to reinvest as you see fit.

Because of how ETFs work, they generally have to distribute far less in capital gains each year than a comparable mutual fund (you can read about the details here if you’re curious why that is).

Some types of ETFs are a little more likely to have gains to distribute than others: bond funds, for instance, that target a specific maturity range—like 5- to 10-year Treasurys—are constantly selling the bonds that fall below the target-maturity floor and replacing them with new ones that are older. That can create some gains, and those will get distributed out to you.

Precious Metals ETFs

There are a few places where your ETF taxes can be a little bit different, the most notable of which is in precious metals ETFs. ETFs like the SPDR Gold Trust (GLD | A-100) have made investing in precious metals easy and convenient, but there’s a small wrinkle when it comes to taxes.

You won’t get any capital gains distributions from them—they’re not doing any buying and selling, they just hold on to bars of metal—but when you go to sell, the IRS will pretend you’ve been owning the bars yourself.

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Shares in a precious metals ETF are actually treated like a collectible—yes, like wine, or art. Any gains you make from selling your gold or silver or platinum ETF will be taxed at 28 percent if you’ve held it for more than a year, or at your ordinary income rate if less than a year (just like any other security).

Reporting this isn’t hard—there’s a whole separate line for it on your tax forms—but you do need to keep track of those gains separately from your regular ETFs. Note: There are a few, small ETFs tracking gold that have different tax treatments, so if you’re in a product from someone other than iShares, SPDR or ETFS, check our segment report on investing in gold.

Other Commodities

If you’ve used an ETF to get access to commodities other than gold, things can get a little trickier. Most commodity ETFs are structured as “commodities pools” as far as the IRS is concerned, and that means you get a tax form at the end of the year that might be a surprise—the K-1 Partnership form. On top of that, the way capital gains are figured for investing in commodities futures is quite different from any other kind of investing.

At the end of the year, the ETF will tell you what the gains on its securities are, and you’ll have to pay a special capital gains tax (a blend of 60 percent of your long-term and 40 percent of your short-term capital gains rate) on that amount—whether you sold or whether you received any distributions.

Again, like the gold funds, there are notable exceptions to this, so if you’re investing in commodities, you should read the report for each fund by typing “http://etf.com/(insert ticker here)” for each fund, and read up on how the IRS will handle any capital gains.

Need More?

The important thing to remember here is that the vast majority of ETFs are going to be handled just like a stock or a mutual fund—but likely with fewer distributions. That’s a good thing. If you’re curious about all the ins and outs, we publish an annual ETF tax guide that can help you wade through the exceptions to the rules, and that covers special cases. We also highlight anything out of the ordinary when it comes to taxes on every fund page, so if you’re in doubt, we have all the information for you at your fingertips.

If you’re browsing for ETFs using our ETF Finder, there’s a separate tab in the search results that can help you separate the simple from the complicated, which will even let you sort by maximum capital gains rate.


At the time this article was written, the author held no positions in the security 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.