The potential tax advantages of buying an ETF

taxesWith April fast approaching we are all managing our tax obligations from last year. When preparing all the documentation for my accountant, I always tell myself that this year I will be smarter. I will make wise decisions with my money and take advantage of all of the legal tax loopholes available to me. We here at etfdailynews are not tax experts, so check with your accountant first, but see below for one more reason you might choose an ETF for your investment vehicle.

ETFs can be easily employed to help investors minimize their tax consequences. Year-end is prime time for investors to evaluate their portfolios’ tax exposure. Investors can structure tax-swap transactions using ETFs to harvest tax losses while avoiding the impact of wash-sale rules. A tax swap is defined as the sale of one security, followed by the simultaneous purchase of a similar investment. The sale of the security purchased at the higher price potentially triggers a loss, which can be used to offset gains realized elsewhere in the portfolio. This may help to reduce taxes due for the current year, or fund the purchase of additional positions in order to realize gains that could be offset by the loss. If there are no realized gains in the current year, losses can be carried forward and used to offset gains in future years. More importantly, tax swaps enable investors to maintain or alter their desired market exposure when they do take a loss.
Whether the objective is to harvest losses from mutual funds, concentrated stock positions or another ETF, the investor may choose to hold the ETF purchased in place of the sold position for its diversification benefit. Alternatively, the investor can sell the ETF after 31 days have passed, pursuant to the wash-sale rule, and then re-purchase the original position.

Sample Uses:

Harvest losses from a concentrated stock position
Sector ETFs may enable an investor to maintain exposure to a particular market segment while simultaneously harvesting the loss from a losing position. An investor with an underwater position in a biotech firm sells the stock to harvest the loss and then purchases an ETF with a high correlation to the sold position. By doing so, the investor maintains her exposure to, or conviction in, the sector while increasing the diversification of her portfolio.





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