From Forbes.com You don’t own exchange-traded funds in your taxable account? You’re missing out. You do? Then you’re benefitting from a nifty loophole. Don’t be surprised if it goes away.
The loophole has not gone unnoticed among academics, and if their cries for reform are heard by politicians, ETF investors are going to owe more in capital gain taxes.
As the law stands now, ETFs pay scant capital gain dividends, even when the market is steaming up and lots of investors are going in and out of the fund. With an ETF you get pretty much the same tax treatment you’d get if you bought the component stocks and never sold any. That makes it a terrific buy for the taxable account of a buy-and-hold investor.
The investor in an open-end fund isn’t so lucky. Suppose this fund owns shares of Apple and Nvidia, and the shares shoot up in price. If enough fund customers want out, the fund will be forced to sell appreciated Apple and Nvidia shares to pay them off. That will generate a capital gain for the fund. The gain will be distributed to all fund investors, including the investor who stays put. That isn’t fair to the stand-patter, but it’s how the tax laws work.
A cap gain distribution doesn’t make anybody richer. If your $50 fund disburses a $4 capital gain, it becomes worth $46 right after. You’ve got the same $50 you had before, but now the IRS wants a piece of the $4.
Contrast two almost identical funds, Dreyfus S&P 500 Index (PEOPX) and BlackRock’s iShares Core S&P 500 (IVV). They both own Apple, Nvidia and 498 other stocks. The Dreyfus fund is organized the old-fashioned way, as an open-end fund that redeems departing customers in cash. The iShares item is an ETF, which makes no cash redemptions. Continue Reading Here