Because exchange traded funds (ETFs) offer a dynamic product that can serve as a buy-and-hold or buy-and-sell investment, they can offer investors the opportunity to reap long-term or short-term gains. Knowing the difference between the two is crucial, especially when it comes time for taxes.
When investors sell an asset for or a profit, the Internal Revenue Service (IRS) denotes this as a capital gain and vice versa for a loss. Investors should be cognizant of both because taxes are owed on a capital gain and income could be offset with a loss.
For capital gains, there’s more discernment to determine the tax owed: whether the gain was short- or long-term. This is due to the various tax rates applied to short-term gains versus long-term gains, which also involves other factors such as tax bracket based on income.
Quite simply, a short-term gain is a capital gain attained if an investors buys and subsequently sells the asset within a year. Conversely, a long-term capital gain is where an investor buys and then sells an asset held longer than one year.
A day trader who purchases shares of an ETF and sells it within the hour to extract a profit is an example of a short-term capital gain. An investor who buys and holds a bond ETF for three years then subsequently sells it, will be subjected to a long-term capital gain.
Know the Tax Implications of Your ETFs
As previously mentioned, one thing investors should be duly aware of are the tax implications associated with short- and long-term gains made in the market. The tax rate will depend on the investor’s tax bracket—refer to the following IRS tables to determine the short- and long-term capital gains tax rate based on income bracket and other qualifiers.
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|Single||Up to $44,625||$44,626 – $492,300||Over $492,300|
|Married filing jointly||Up to $89,250||$89,251 – $553,850||Over $553,850|
|Married filing separately||Up to $44,625||$44,626 – $276,900||Over $276,900|
|Head of household||Up to $59,750||$59,751 – $523,050||Over $523,050|
|Tax rate||Single||Head of household||Married filing jointly or qualifying widow||Married filing separately|
|10%||$0 to $11,000||$0 to $15,700||$0 to $22,000||$0 to $11,000|
|12%||$11,001 to $44,725||$15,701 to $59,850||$22,001 to $89,450||$11,001 to $44,725|
|22%||$44,726 to $95,375||$59,851 to $95,350||$89,451 to $190,750||$44,726 to $95,375|
|24%||$95,376 to $182,100||$95,351 to $182,100||$190,751 to $364,200||$95,376 to $182,100|
|32%||$182,101 to $231,250||$182,101 to $231,250||$364,201 to $462,500||$182,101 to $231,250|
|35%||$231,251 to $578,125||$231,251 to $578,100||$462,501 to $693,750||$231,251 to $346,875|
|37%||$578,126 or more||$578,101 or more||$693,751 or more||$346,876 or more|
There are certain instances that warrant nuanced tax knowledge. For example, physically backed gold ETFs can be taxed at a top rate of 28% when it comes to long-term capital gains versus the standard 20% rate — this is because ETFs backed by physical gold are treated as collectibles.
Given their complexity, any tax questions regarding ETFs should be directed to an accountant.
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