Tax Strategies for ETFs You Should Know (2024)

The ease of buying and sellingexchange-traded funds (ETFs), along with their lowtransaction costs, offer investors anefficient portfolio-enhancing tool. Tax efficiency is another important part of their appeal. Investors need to understand the tax consequences of ETFs so that they can be proactive with their strategies.

We'll begin by exploring the tax rules that apply to ETFs and the exceptions you should be aware of, and then we will show you some money-saving tax strategies that can help you get a high return and beat the market.

Key Takeaways

  • Exchange-traded funds have different tax rules, depending on the assets they hold.
  • For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains.
  • If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
  • If an ETF purchase is underwater when you approach the one-year mark, you may consider selling it as a short-term capital loss.
  • High earners are also subject to the 3.8% Net Investment Income Tax on ETF sales.

Taxes on ETFs

ETFs enjoy a more favorable tax treatment than mutual funds due to their unique structure. ETFs create and redeem shares with in-kind transactions that are not considered sales. As a result, they do not create taxable events. However, when you sell an ETF, the trade triggers a taxable event. Whether it is a long-term or short-term capital gain or loss depends on how long the ETF was held. In the United States, to receive long-term capital gains treatment, you must hold an ETF for more than one year. If you hold the security for one year or less, then it will receive short-term capital gains treatment.

Dividends and Interest Payment Taxes

Dividends and interest payments from ETFs are taxed similarly to income from the underlying stocks or bonds inside them. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. If you earn a profit by selling an ETF, they are taxed like the underlying stocks or bonds as well.

ETFs held for more than a year are taxed at the long-term capital gains rate, which goes up to 20%. Individuals with substantial income from investing may also pay an additional 3.8%Net Investment Income Tax (NIIT). ETFs held for less than a year are taxed at ordinary income rates, with the top end of that range at 37%, plus an additional 3.8% NIIT for some investors.

As with stocks, with ETFs, you are subject to the wash-sale rules if you sell an ETF for a loss and then buy it back within 30 days. A wash sale occurs when you sell or trade a security at a loss, and then within 30 days of the sale you:

  • Buy a substantially identical ETF;
  • Acquire a substantially identical ETF in a fully taxable trade; or
  • Acquire a contract or option to buy a substantially identical ETF.

If your loss was disallowed because of the wash-sale rules, you should add the disallowed loss to the cost of the new ETF. This increases your basis in the new ETF. This adjustment postpones the loss deduction until the disposition of the new ETF. Your holding period for the new ETF begins on the same day as the holding period of the ETF that was sold.

Many ETFs generate dividends from the stocks they hold. Ordinary (taxable) dividends are the most common type of distribution from a corporation. According to the IRS, you can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation tells you otherwise. These dividends are taxed when paid by the ETF.

Qualified dividends are subject to the same maximum tax rate that applies to net capital gains. Your ETF provider should tell you whether the dividends that have been paid are ordinary or qualified.


The number of exchange-traded funds available to U.S. investors as of 2023, according to Morningstar Investments.

Exceptions - Currency, Futures, and Metals

As in just about everything, there are exceptions to the general tax rules for ETFs. An excellent way to think about these exceptions is to know the tax rules for the sector. ETFs that fit into certain sectors follow the tax rules for the sector rather than the general tax rules. Currencies, futures, and metals are the sectors that receive special tax treatment.

Currency ETFs

Most currency ETFs are in the form of grantor trusts. This means the profit from the trust creates a tax liability for the ETF shareholder, which is taxed as ordinary income. They do not receive any special treatment, such as long-term capital gains, even if you hold the ETF for several years. Since currency ETFs trade in currency pairs, the taxing authorities may assume that these trades take place over short periods.

Futures ETFs

These funds trade commodities, stocks, Treasury bonds, and currencies. For example, Invesco DB Agriculture ETF (DBA) invests in futures contracts of the agricultural commodities — corn, wheat, soybeans, and sugar - not the underlying commodities. Gains and losses on the futures within the ETF are treated for tax purposes as 60% long-term and 40% short-term regardless of how long the ETF held the contracts. Further, ETFs that trade futures follow mark-to-market rules at year-end. This means that unrealized gains at the end of the year are taxed as though they were sold.

Metals ETFs

If you trade or invest in gold, silver, or platinum bullion, the tax authorities consider it a "collectible" for tax purposes. The same applies to ETFs that trade or hold gold, silver, or platinum. As a collectible, if your gain is short-term, then it is taxed as ordinary income. If your gain is earned for more than one year, then you are taxed at a capital gains rate of up to 28%. This means that you cannot take advantage of normal capital gains tax rates on investments in ETFs that invest in gold, silver, or platinum. Your ETF provider will inform you what is considered short-term and what is considered long-term gains or losses.

Tax Strategies Using ETFs

ETFs lend themselves to effective tax-planning strategies, especially if you have a blend of stocks and ETFs in your portfolio. One common strategy is to close out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way, your gains receive long-term capital gains treatment, lowering your tax liability. Of course, this applies for stocks as well as ETFs.

In another situation, you might own an ETF in a sector you believe will perform well, but the market has pulled all sectors down, giving you a small loss. You are reluctant to sell because you think the sector will rebound and you could miss the gain due to wash-sale rules. In this case, you can sell the current ETF and buy another that uses a similar but different index. This way, you still have exposure to the favorable sector, but you can take the loss on the original ETF for tax purposes.

ETFs are a useful tool for year-end tax planning. For example, you own a collection of stocks in the materials and healthcare sectors that are at a loss. However, you believe that these sectors are poised to beat the market during the next year. The strategy is to sell the stocks for a loss and then purchase sector ETFs which still give you exposure to the sector.

What Are the Tax Advantages of ETFs?

Exchange-traded funds tend to be more tax-efficient than actively-managed funds, because they require less rebalancing and incur fewer taxable events.

How Does the NIIT Work?

The Net Investment Income Tax is a 3.8% tax on investment trades by individuals and trusts who earn more than a certain income threshold every year. As of 2024, the income thresholds are $200,000 for single filers and $250,000 for those married filing jointly.

How Do I Handle Dividends on ETF Taxes?

ETF dividends are taxed according to how long you hold the fund. If you hold the fund for less than 60 days before the dividend is issued, you will be taxed at your normal income tax rate. If you buy the fund 60 days or longer before the dividend is issued, it is considered a "qualified dividend" and taxed at a rate of 0% to 20%.

How Are Spot Bitcoin ETFs Taxed?

Spot ETFs that hold cryptocurrency will most likely be structured as grantor trusts, subjecting them to the same taxation rules that govern spot commodity ETFs, according to Grayscale, which operates one of the leading spot bitcoin ETFs. Previous crypto ETFs invested in futures contracts, subjecting them to the 60/40 rule.

The Bottom Line

Investors who use ETFs in their portfolios can add to their returns if they understand the tax consequences of their ETFs. Due to their unique characteristics, many ETFs offer investors opportunities to defer taxes until they are sold, similar to owning stocks. Also, as you approach the one-year anniversary of your purchase of the fund, you should consider selling those with losses before their first anniversary to take advantage of the short-term capital loss. Similarly, you should consider holding those ETFs with gains past their first anniversary to take advantage of the lower long-term capital gains tax rates.

ETFs that invest in currencies, metals, and futures do not follow the general tax rules. Rather, as a general rule, they follow the tax rules of the underlying asset, which usually results in short-term gain tax treatment. This knowledgeshould help investors with their tax planning.

Tax Strategies for ETFs You Should Know (2024)


Tax Strategies for ETFs You Should Know? ›


An ordinary loss is loss realized by a taxpayer when expenses exceed revenues in normal business operations. Ordinary losses are those losses incurred by a taxpayer which are not capital losses. An ordinary loss is fully deductible to offset income thereby reducing the tax owed by a taxpayer. › terms › ordinary-loss
harvesting with ETFs can be an effective way to minimize or defer tax liability on capital gains. The most important thing to keep in mind with this strategy is the wash sale rule. Investors must be careful in choosing exchange-traded funds to ensure that their tax-loss harvesting efforts pay off.

How do I avoid taxes on my ETF? ›

One common strategy is to close out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way, your gains receive long-term capital gains treatment, lowering your tax liability.

What is the 30 day rule on ETFs? ›

Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.

Which ETF is most tax efficient? ›

Top Tax-Efficient ETFs for U.S. Equity Exposure
  • iShares Core S&P 500 ETF IVV.
  • iShares Core S&P Total U.S. Stock Market ETF ITOT.
  • Schwab U.S. Broad Market ETF SCHB.
  • Vanguard S&P 500 ETF VOO.
  • Vanguard Total Stock Market ETF VTI.

Do ETFs offer a favorable tax treatment? ›

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.

Do I pay taxes on ETFs if I don't sell? ›

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

Can you write off ETF losses? ›

Tax loss rules

Losses in ETFs usually are treated just like losses on stock sales, which generate capital losses. The losses are either short term or long term, depending on how long you owned the shares. If more than one year, the loss is long term.

What is the 3 5 10 rule for ETF? ›

Specifically, a fund is prohibited from: acquiring more than 3% of a registered investment company's shares (the “3% Limit”); investing more than 5% of its assets in a single registered investment company (the “5% Limit”); or. investing more than 10% of its assets in registered investment companies (the “10% Limit”).

Is it OK to hold ETF long-term? ›

Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.

What is the 3% limit on ETFs? ›

Under the Investment Company Act, private investment funds (e.g. hedge funds) are generally prohibited from acquiring more than 3% of an ETF's shares (the 3% Limit).

What ETFs are tax free? ›

  • Fidelity Municipal Bond Index Fund (FMBIX)
  • Vanguard Tax-Exempt Bond ETF (VTEB)
  • Vanguard Short-Term Tax-Exempt Bond ETF (VTES)
  • Vanguard High-Yield Tax-Exempt Fund Investor Shares (VWAHX)
  • iShares New York Muni Bond ETF (NYF)
  • iShares California Muni Bond ETF (CMF)
  • iShares National Muni Bond ETF (MUB)
Apr 25, 2024

Why do ETFs avoid capital gains? ›

Why? For starters, because they're index funds, most ETFs have very little turnover, and thus amass far fewer capital gains than an actively managed mutual fund would. But they're also more tax efficient than index mutual funds, thanks to the magic of how new ETF shares are created and redeemed.

Is VOO or VTI more tax efficient? ›

Tax Efficiency – Tie

ETFs tend to distribute comparatively fewer capital gains to shareholders – these same gains are simply more challenging to manage efficiently from a mutual fund. Overall, VOO and VTI are considered to have the same level of tax efficiency.

How long should you hold ETFs? ›

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

Should you hold ETFs in a taxable account? ›

For investors who like the convenience and built-in diversification of a mutual fund, equity exchange-traded funds can make fine, tax-efficient options for taxable accounts. Most ETFs track indexes, so their turnover is often very low, meaning that capital gains distributions also tend to be few and far between.

What are three disadvantages to owning an ETF over a mutual fund? ›

Disadvantages of ETFs
  • Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
  • Operating expenses. ...
  • Low trading volume. ...
  • Tracking errors. ...
  • The possibility of less diversification. ...
  • Hidden risks. ...
  • Lack of liquidity. ...
  • Capital gains distributions.

How do I avoid paying taxes on ETF dividends? ›

Investors should remember that ETF dividends are not taxed while held in a retirement account, such as an individual retirement account (IRA) or a 401(k). This is because investments held in a qualified retirement account grow tax deferred.

Which type of ETF distribution is tax free? ›

If investors hold ETFs within a tax- sheltered account (RRSP, RRIF, RESP, or TFSA), distributions are not taxed and investors will not receive a tax form.

Can I convert a mutual fund to an ETF without paying taxes? ›

The conversion itself is tax-free to the investor and switches from actively managed mutual funds, which aim to outperform the market. The primary benefit of the new ETF is more tax efficiency. “That's a big selling point,” Sotiroff said.

How long should you hold an ETF? ›

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

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