More On Tax Planningfrom The Advisor's Professional Library
- ETF Taxation The use of ETFs may be attractive to certain investors. The tax advantages may make them even more attractive.
- Taxation of Real Estate Real estate may be used to shelter income and may offer certain tax benefits. However, the type of real estate investment may result in different tax treatment. Learn how to use these investments to help your clients.
As part of AdvisorOne’s Special Report, 20 Days of Tax Planning Advice for 2013, throughout the month of March, we are partnering with our Summit Business Media sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format. In this 10th article, we look at the tax advantages of ETFs.
Q. What are the tax advantages of owning ETFs?
One of the advantages of owning ETFs is their tax efficiency.
ETFs enjoy a more favorable tax treatment than mutual funds due to their unique structure. Mutual funds 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.
Planning Point: Long term capital gains are normally taxed at a favorable rate, at least for 2012.
As with stocks, 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 within 30 days after 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
Planning Point: 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 as ordinary income.
Qualified dividends are subject to the same maximum tax rate that applies to net capital gains. In order to qualify:
1. An American company or a qualifying foreign company must have paid the dividend.
2.The dividends must not be listed with the IRS as dividends that do not qualify.
3. The required dividend holding period must be met.
The ETF provider should tell you whether the dividends that have been paid are ordinary or qualified.
For more tax stories and advice, check out AdvisorOne’s 20 Days of Tax Planning Advice for 2013 home page.