How do I avoid taxes on ETFs?
Tax Strategies Using ETFs
- iShares National Muni Bond ETF (MUB)
- Vanguard Tax-Exempt Bond Index Fund Admiral Shares (VTEAX)
- Vanguard Short-Term Tax-Exempt Bond ETF (VTES)
- Vanguard High-Yield Tax-Exempt Fund Investor Shares (VWAHX)
- iShares California Muni Bond ETF (CMF)
- iShares New York Muni Bond ETF (NYF)
To avoid a wash sale, you could replace it with a different ETF (or several different ETFs) with similar but not identical assets, such as one tracking the Russell 1000® Index.
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
In these cases, investors don't have to pay extra taxes when a mutual fund they own converts to an ETF. Brokerage account holders simply get the value of their mutual fund investment transferred tax-free into the ETF version. The new ETF has the same managers and portfolio that the mutual fund had.
The ETF tax loophole works only on capital gains, though. Other kinds of taxable income, such as bond interest and dividend payments, are still passed along each year to investors, who must include them in that year's taxable income.
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.
From the perspective of the IRS, the tax treatment of ETFs and mutual funds are the same. Both are subject to capital gains tax and taxation of dividend income.
Just as how long you have to wait to sell a stock after buying it, there is no legal limit on the number of times you can buy and sell the same stock in one day. Again, though, your broker may impose restrictions based on your account type, available capital, and regulatory rules regarding 'Pattern Day Traders'.
You may have to pay capital gains tax on stocks sold for a profit. Any profit you make from selling a stock is taxable at either 0%, 15% or 20% if you held the shares for more than a year. If you held the shares for a year or less, you'll be taxed at your ordinary tax rate.
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.
How long should you keep ETFs? It depends on your investment goals and how long you want to stay invested in ETFs. While a long-term ETF holding for more than three years can get you better returns, short-term returns can also be more for some ETFs.
Hold ETFs throughout your working life. Hold ETFs as long as you can, give compound interest time to work for you. Sell ETFs to fund your retirement. Don't sell ETFs during a market crash.
- Trading fees.
- Operating expenses.
- Low trading volume.
- Tracking errors.
- The possibility of less diversification.
- Hidden risks.
- Lack of liquidity.
- Capital gains distributions.
Hold Funds in a Retirement Account
This means you can sell shares of your mutual fund or collect a capital gains distribution without paying the relevant taxes so long as you keep the money in that retirement account. You will ultimately owe any related taxes once you withdraw the money, of course.
Realistically, it comes down to preference and what you're doing. ETFs can be used by traders to take advantage of price movements throughout the day. If you don't plan to trade throughout the day, a mutual fund might work better if you choose one with lower costs.
If you sell an equity or bond ETF, any gains will be taxed based on how long you owned it and your income. For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners.
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
The rule mandates that an investor cannot claim a loss on the sale of an investment and then buy a “substantially identical” security for the period beginning 30 days before and ending 30 days after the sale.
ETF trading generally occurs in-kind, meaning they are not redeemed for cash. Mutual fund shares can be redeemed for money at the fund's net asset value for that day. Stocks are bought and sold using cash.
Can you sell an ETF whenever you want?
Trading ETFs and stocks
There are no restrictions on how often you can buy and sell stocks or ETFs. You can invest as little as $1 with fractional shares, there is no minimum investment and you can execute trades throughout the day, rather than waiting for the NAV to be calculated at the end of the trading day.
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.
Each November the majority of mutual fund companies announce and distribute capital gains to each of their shareholders. Capital gains are realized anytime you sell an investment and make a profit. And, yes this applies to all mutual fund shareholders even if you didn't sell your shares during the year.
Investors can choose to hold their ETFs for a return in action. Nonetheless, a decline in liquidity can mean a drop in value for both the short and long term, which makes investors more likely to sell.
Some traders follow something called the "10 a.m. rule." The stock market opens for trading at 9:30 a.m., and the time between 9:30 a.m. and 10 a.m. often has significant trading volume. Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour.
