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Sorry if this is a very novice question. I couldn't find it by searching here or Bogleheads (I'm not really a 100% Boglehead either).

Let's say I hold $30,000 in an ETF called BMT (Big Mike's Tech). And the breakdown of the BMT ETF is:

  • 33% Oracle
  • 33% Apple
  • 33% Yelp

and 7 months down the road they sell Oracle for TIBCO. Yet I hold the ETF for 13 months. Do I pay the short-term capital gains on the Oracle for TIBCO change? Or do I just pay long-term capital gains on Big Mike's Tech ETF because I just exchanged that?

to sum it up quickly. If i buy 5 shares of an etf called BMT. no matter what BMT does with their money i only pay taxes when i sell my 5 shares of BMT (an etf, even if they turn over their assets everyday?)

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  • How is the ETF turning over the assets? Through creation/redemption units or the fund itself trading stocks? If the former then there may not be capital gains while the latter would have capital gains.
    – JB King
    Commented Mar 31, 2014 at 6:03

2 Answers 2

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Generally speaking, each year, mutual funds distribute to their shareholders the dividends that are earned by the stocks that they hold and also the net capital gains that they make when they sell stocks that they hold. If they did not do so, the money would be income to the fund and the fund would have to pay taxes on the amount not distributed. (On the other hand, net capital losses are held by the fund and carried forward to later years to offset future capital gains). You pay taxes on the amounts of the distributions declared by the fund. Whether the fund sold a particular stock for a loss or a gain (and if so, how much) is not the issue; what the fund declares as its distribution is. This is why it is not a good idea to buy a mutual fund just before it makes a distribution; your share price drops by the per-share amount of the distribution, and you have to pay taxes on the distribution.

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Generally, ETFs and mutual funds don't pay taxes (although there are some cases where they do, and some countries where it is a common case).

What happens is, the fund reports the portion of the gain attributed to each investor, and the investor pays the tax.

In the US, this is reported to you on 1099-DIV as capital gains distribution, and can be either short term (as in the scenario you described), long term, or a mix of both. It doesn't mean you actually get a distribution, though, but if you don't - it reduces your basis.

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