In regards to the section on tax efficiency [in this article about Active ETFs], it says it can create basket of stocks and exchange in kind.
Does that mean that if even the investor sells their investment at a profit there will be no capital gains taxes on the gains, or if it at a loss can’t use the capital losses to offset gains?
Also, how is the investor impacted by the “active” trading by the etf manager when buying and selling within the active etf? is it always done as in kind exchange and therefore doesnt incur any taxes to the etf investor?
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Hi Flavia,
The first fundamental question I would ask you is the type of account you are using. A retirement account will function differently than a non-retirement regular brokerage account. If you are using a regular brokerage account, then an investor that sells an ETF, whether an active or passive ETF, would still pay capital gains taxes if the investor has had a gain over their cost basis (what they paid for it). An investor with other losses from investments that year or carried over from other years can offset gains. However, an investor can not deduct more than $3000 in total net losses in a year.
Active ETFs tend to be traded less than mutual funds, which is part of the reason they are more tax-efficient than mutual funds. In addition, the ability of active ETFs to use the in-kind redemption process is another reason why active ETFs operate tax efficiently. Non the less passive ETFs will be the most tax-efficient compared to active ETFs and mutual funds.
Hope that helps,
Nathan Mueller, MBA, CFP®