How do ETF taxes work?

Ever since their arrival in 1993, exchange-traded funds (ETFs) have been growing in popularity. They exploded in popularity after the recession in 2008. This is because ETFs are an excellent means for enhancing portfolios and generating wealth. However, taxes on ETFs can be a little confusing. It is important to spend some time learning how ETF taxes work before you invest.

How do ETF taxes work?

ETFs use a unique structure. The shares created and redeemed with in-kind transactions are not considered sales, which means they are not taxable events. However, you do owe taxes when you sell an ETF.

Depending on how long you have held the ETF, it will be taxed as a long-term capital gain or a short-term capital gain. The maximum tax rates for long-term capital gains vary depending on the type of ETF you hold, but the maximum rate for short-term for all types of ETFs is 40.8% (ordinary income top tax rate of 37% plus net investment income tax, aka “Obamacare” tax).

Using ETFs for your tax strategy

If you use ETFs correctly, you can form an efficient tax planning strategy. Some investors choose to sell ETFs that will report losses before their one-year maturation period while keeping the ones that have positive gains for longer than one year. This is called tax-loss harvesting and is a great way to move positive ETFs into the beneficial long-term capital gains tax qualification while lowering your tax liability for the year by getting rid of the underperforming investments. 

Talk to a ProVise CFP® professional about making investment decisions

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