How Taxes Work for Different Exchange-Traded Investments
Not every exchange-traded product you read or hear about is, technically, an exchange-traded fund. And this isn’t just a matter of semantics. The structure of each investment determines how your earnings are taxed. Here’s a rundown:
A Regular ETF
This kind of investment owns a basket of assets. For example, PowerShares QQQ (symbol QQQ) owns the stocks in the Nasdaq 100 index.
What taxes you’ll owe and when: Tax treatment is the same as that for mutual funds. When you sell an ETF, profits on shares held more than one year are considered long-term and taxed by Uncle Sam at a top rate of 15%; short-term gains are taxed as ordinary income, up to 35%. You pay taxes on distributions of interest and short-term gains at the ordinary income tax rate. Qualified dividends are taxed at a top rate of 15%, as are distributions of long-term capital gains.
Precious-Metal Commodity ETFs
What taxes you’ll owe and when: You’ll be taxed as if you owned a collectible, such as a piece of art or a baseball card. If you hold a collectible for more than a year, you’ll be taxed at a top federal rate of 28%. If you’re in a lower bracket, you will pay taxes on profits at your ordinary income tax rate. If you sell the ETF within a year of buying it, any profits will be taxed as ordinary income, at a rate of up to 35%.
Futures-Based Commodity ETFs
These ETFs, such as United States Oil (USO), buy futures contracts to track the price of a commodity. They are often structured as limited partnerships.
What taxes you’ll owe and when: You’ll have to contend with a Form K-1 sent by the ETF’s sponsor. Moreover, any appreciation you get while you hold the ETF will be taxed yearly as capital gains on a 60/40 schedule -- 60% at long-term rates and 40% at short-term rates -- whether or not you sell the fund.
ETNs are unsecured debt issued by an investment bank, which promises to pay the value of an index, minus the ETN’s expenses.
What taxes you’ll owe and when: ETNs typically don’t generate dividends or make interest distributions. You pay taxes on profits when you sell your shares. Exceptions: With currency ETNs, any interest income is taxed as ordinary income on an annual basis.
Leveraged and Inverse ETFs
These investment products accomplish their goals using derivatives, such as options and futures contracts.
What taxes you’ll owe and when: When you sell, profits will be taxed at short-term capital-gains rates, even if you owned the shares for more than a year. Also, if the fund distributes capital gains to shareholders, the gains will be taxed as ordinary income.