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It is my understanding that if an investor buys an open ended mutual fund and the fund distributes a capital gain to the investor then that gain can be offset by the investor selling a stock (or another mutual fund) for a capital loss. Am I right about this? Is the same true for an ETF?

If the answer is yes to the first question and no to the second, it seems to me that this is a significant advantage for mutual funds.

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  • Differences between mutual funds and ETF here. ETFs are generally index funds, which don't buy and sell securities as much, so they tend to generate fewer capital gains. But any gains they generate are passed through, and taxed just like mutual fund CG distributions.
    – Barmar
    Commented Dec 18, 2022 at 15:01
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    The linked comparison between mutual funds and ETFs is good. One quibble is their example saying that if an investor in a fund redeems 50k in shares the fund has to sell that much stock, perhaps triggering capital gains. The sale is only for net redemptions. If another investor buys 50k in shares the same day the fund just delivers the cash from the second to the first and doesn't sell anything.
    – Ross Millikan
    Commented Dec 18, 2022 at 17:30

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The taxes on the dividends or capital gains of an ETF or a mutual fund are treated identically by the IRS. The big difference tax wise isn't ETF vs mutual fund, it is taxable vs non-taxable vs tax defered.

The investment inside a 401(k) or IRA or the Roth versions of those will either avoid taxes entirely, or defer the taxes on dividends or capital gains.

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  • I was assuming that it was done in a taxable account. Are you telling me that for both a mutual fund and an ETF the capital gain is passed through? That is, the answer to my two questions above is yes and yes?
    – Bob
    Commented Dec 18, 2022 at 2:55
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    Perhaps you should add that the (qualified) dividends and capital gains within a tax-deferred retirement account such as a 401(k) or a Traditional IRA lose their preferential tax status; that is, distributions from these accounts are taxed as ordinary income.
    – Dilip Sarwate
    Commented Dec 18, 2022 at 14:52

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