Etf Tax Planning

Chartwell Law Firm - Etf Tax Planning

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While exchange-traded funds (Etfs) are well known for their low cost, transparency and flexibility, the tax efficiency advantage of Etfs frequently gets overlooked. As we head into the last month of the year, let's look at how investors may lower their tax liabilities by converting some positions in their portfolio to Etfs as well as discuss other Etf strategies to sell out tax burdens. Since every venture situation is different, please be sure to consult tax counsel before taking action.

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Like higher expenses, tax consequences can negatively impact fund performance. Etfs are more tax productive than actively managed mutual funds. Some mutual fund managers are prone to selling position late in the year to lock in capital gains. These gains are then distributed to current shareholders on a pro rata basis.

Because Etfs track indexes which commonly buy and sell securities far less often than mutual funds, most Etfs rarely distribute any pesky end-of- the- year capital gains distributions that are detailed in those 1099 forms that gain in your tax file. Ishares, the largest house of Etfs, has never distributed any capital gains to iShares investors.

In addition, mutual fund shareholders purchase and redeem shares from the fund - which may corollary in gains distributed to all shareholders. The killer is that these capital gains known in the venture business as "imbedded capital gains" may come from the sale of a mutual fund stock retention that goes back many years - well before the current shareholder invested in the fund. In incompatibility to mutual fund investors, Etf shareholders buy and sell Etfs on an exchange, a transaction that does not influence other shareholders. Etf investors clearly have better operate and transparency of their tax situation.

While you can see the tax advantages of Etfs, you may not be aware of their use as a toll to sell out your tax burden. Let me highlight a few of them.

Let's assume you have a small cap mutual fund that has declined ,000 since its purchase three years ago and you want to apply the capital loss but still want small cap exposure. You could sell the mutual fund and simultaneously spend the proceeds in the iShares Russell 2000 Etf (Iwm). The key is to avoid switching to an Etf that is similar but not selfsame or you may come into disagreement of the wash sale rule whereby buying the same or a substantially selfsame security within 30 days after a sale defers the capital loss. You could then apply this ,000 towards other capital gains distributions to lower your allinclusive tax liabilities.

You could also use this tax loss harvesting to re-balance your allinclusive portfolio. In the above example, you might have wanted to cut back a bit on small cap exposure and allocated more to a large cap Etf like the Vanguard Large Cap Etf.

An investor could also Etfs to take care of a range of personel stocks which are being held at a loss. For example, an investor with a loss on a portfolio of healthcare stocks could sell the securities and then purchase a sector Etf such as the iShares Dow Jones U.S. Healthcare Sector Etf (Iyh).

Switching from a loss position in an actively managed mutual fund to an Etf of policy has double barreled tax benefits. First you can take the capital loss without losing the exposure, and secondly, you have a more tax productive position with a much lower likelihood of time to come capital gains distributions.

Take some time this month to quote your portfolios with your venture or tax advisor. It is a great time to reconsider increasing your Etf holdings with the bonus of perhaps lowering allinclusive tax liabilities for both this year and for time to come years.

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