Tax Advantages of ETFs

By Jeffrey Jackson

ETFs are one of the most attractive investments because of their tax advantages. Because of the way ETFs are created and redeemed, it allows investors to pay taxes upon final sale of the ETF, rather than upon making any return. One must pay taxes, however the money an investor would've paid to taxes could be reinvested to accumulate more wealth.

Any benefits or gains are attached to the marginal tax rate along with the ROI and longevity of it. Tax advantages of ETFs resemble that those of tax manages index funds. ETFs are much more advantageous than actively managed funds.

Normal mutual funds continue to accumulate unrealized capital gains liabilities for any and all stocks that have risen in value. When these stocks are sold, the fund calculates and distributes the capital gains taxes to its members in direct proportion to their ownership. This diminishes any upside gained by allowing money that would be allotted for taxes to accumulate in the ETF and grow.

Both mutual funds and ETFs have modest distribution in comparison to actively managed funds. It's important to emphasize that ETFs have much less capital gains liability than do mutual funds. Funds tend to enforce tax payment the more turnover experience there is from trying to pick stocks.

It's a somewhat hidden although real fact that active mutual fund investors end up stuck paying the bill for others who don't pay, especially in a down market. Investors that sell their stock before the day of record don't receive a tax bill while loyal investors do, and end up paying for it. This is not the case with ETFs.

A loophole with regulation exists under which ETFs are considered to be created by trading alike certificates called an in-kind trade. The IRS does not charge the same capital gain because it is viewed as trading identical items. Traditional mutual funds will exchange cash for stocks which trigger a tax liability from the IRS. ETFs have a huge tax advantage. - 31970

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