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How are actively managed ETFs taxed?


muscleman
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I am curious about active ETFs which try to beat the stock index. They will be actively buying and selling stocks and generate capital gains. What will happen to shareholders of this ETF?

If capital gain is not distributed to shareholders for tax purposes but instead keep compounding in the fund, I double IRS would allow this to happen.

But if it is distributed to shareholders, will shareholders be able to know what portion is long term gain and what portion is short term gain and get different tax rates accordingly?

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I am curious about active ETFs which try to beat the stock index. They will be actively buying and selling stocks and generate capital gains. What will happen to shareholders of this ETF?

If capital gain is not distributed to shareholders for tax purposes but instead keep compounding in the fund, I double IRS would allow this to happen.

But if it is distributed to shareholders, will shareholders be able to know what portion is long term gain and what portion is short term gain and get different tax rates accordingly?

 

Yes, just like mutual funds, ETFs sometimes have to make distributions to shareholders. Information is given to you that tells you which portion is short-term and which is long-term.

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I am curious about active ETFs which try to beat the stock index. They will be actively buying and selling stocks and generate capital gains. What will happen to shareholders of this ETF?

If capital gain is not distributed to shareholders for tax purposes but instead keep compounding in the fund, I double IRS would allow this to happen.

But if it is distributed to shareholders, will shareholders be able to know what portion is long term gain and what portion is short term gain and get different tax rates accordingly?

 

Yes, just like mutual funds, ETFs sometimes have to make distributions to shareholders. Information is given to you that tells you which portion is short-term and which is long-term.

 

Thank you! In this case, what would be the reason for a manager to create an active ETF instead of a mutual fund?

I remember Peter Lynch saying it is bad idea to buy any mutual funds near the end of the year, because investors won't get the distributions but have to bear the tax on the capital gain. Does the same apply for active ETF?

 

 

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I am curious about active ETFs which try to beat the stock index. They will be actively buying and selling stocks and generate capital gains. What will happen to shareholders of this ETF?

If capital gain is not distributed to shareholders for tax purposes but instead keep compounding in the fund, I double IRS would allow this to happen.

But if it is distributed to shareholders, will shareholders be able to know what portion is long term gain and what portion is short term gain and get different tax rates accordingly?

 

Yes, just like mutual funds, ETFs sometimes have to make distributions to shareholders. Information is given to you that tells you which portion is short-term and which is long-term.

 

Thank you! In this case, what would be the reason for a manager to create an active ETF instead of a mutual fund?

I remember Peter Lynch saying it is bad idea to buy any mutual funds near the end of the year, because investors won't get the distributions but have to bear the tax on the capital gain. Does the same apply for active ETF?

 

Because ETFs are getting inflows and mutual funds are not :)

 

It would depend on the particular active ETF, but if it was sitting on unrealized gains and then got outflows during the year, you might expect a similar dynamic to play out with the capital gains distributions.

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Because ETFs are getting inflows and mutual funds are not :)

 

It would depend on the particular active ETF, but if it was sitting on unrealized gains and then got outflows during the year, you might expect a similar dynamic to play out with the capital gains distributions.

 

I find it interesting that even some passive ETFs can have capital gains and distributions!

https://us.spdrs.com/en/resources/capgain/

 

Hmm..... How could this happen to XNTK? Is that because they had to sell some stock because it is removed from the index? I see the ex date is 12/24. So if I buy it right after 12/24, then I won't get the distribution, but I'll still have to pay taxes on the capital gains for this year right?

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It just blows my mind why someone would want to buy these funds....

These funds trade at NAV, but it really should trade at a discount to NAV. Let's say the fund's NAV is $100, but $50 of that NAV is capital gains, and I bought it at $100 per share.

At the end of the year, it distributes $50 to me, and NAV drops to $50, so my share price drops to $50. Now i have to pay taxes on the $50 distribution to me, which could be, say, $20. So now I only have $80 in hand and just lost $20 in a few days by doing nothing!

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ETFs and Mutual Funds could in theory be taxed the same, but no legacy mutual funds (to my knowledge) use in-kind redemptions and creation units with third-party financial institutions (and their MTM tax accounting) intermediaries. 

 

If you want to really know the answer to your question (you don't have it in this thread), google should work.  Alpha architect has some very good and sophisticated stuff on the subject on their site, if memory serves.  Rob Arnott discussed the issue briefly in his recent appearance on the i3/marketfox podcast out of Australia.

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