When Do You Have to Pay ETF Taxes?

When investing in the stock market, it’s important to understand the potential tax consequences of your transactions. Capital gains taxes commonly apply when buying and selling stocks, but exchange-traded funds (ETFs) can follow different tax rules. So when are ETF taxes due? The answer can vary. ETFs may generate taxable events depending on their structure, how they are managed and the types of assets they hold. Before filing your taxes this April, it’s helpful to understand how ETFs are taxed and what that could mean for your overall tax liability.

A financial advisor can help you select the right ETFs for your portfolio’s long-term goals.

What Are ETFs?

Exchange-traded funds (ETFs) are a bundle of securities that combine the diversity of a mutual fund and the ability to be traded like stock.

ETFs are essentially bundles of investments that are specifically put together to track a market index, such as the S&P 500. There are hundreds of unique ETFs traded on U.S. markets, each specializing in a different approach.

In general, ETFs are great picks for beginners and more passive investors who want to set it and forget it. There are fewer fees and lower minimums than many mutual funds, and they offer the diversification a well-balanced portfolio needs.

Realized Gains or Losses From the Sale of ETF Shares

ETFs can offer added efficiency come tax time.

When you understand how ETF taxes work, it can save you a lot of money. However, this is complicated by the fact that different ETFs are taxed differently.

ETFs may be subject to short-term or long-term gains, depending on how long you have held the asset:

Short-term capital gains. Short-term capital gains, which are the profits derived from an asset that’s sold within a year of purchase, are taxed as ordinary income.
Long-term capital gains. Long-term capital gains are the profits realized when you sell an asset held for over a year. Long-term gains receive a more favorable tax treatment, with tax rates at 0%, 15% or 20%, depending on your income.

Tax treatment also depends on the type of ETF. However, individuals with substantial income will face an additional 3.8% net investment income tax (NIIT), which we have included in these calculations.

Equity and Bond ETFs

Equity and bond ETFs top out at normal short- and long-term capital gains rates.

Short-term capital gains tax. If you sell after holding for less than a year, you can be taxed up to 40.8%.
Long-term capital gains tax. For those held for longer than a year, your maximum tax rate is 23.8%.

Precious Metals ETFs

The IRS taxes ETFs that invest in precious metals like they were precious metals themselves, which means they’re taxed as collectibles.

Short-term capital gains tax. Short-term capital gains are still taxed at the normal income rate.
Long-term capital gains tax. Long-term capital gains tax on collectibles rises to 28% (NIIT included), which is higher than the 23.8% capital gains tax on an equity ETF for the highest-income earners.

Commodities ETFs

The taxation of commodity ETFs can be fairly complex.

They deal in futures contracts and are often structured as limited partnerships. As a limited partnership, these ETFs send schedule K-1 forms instead of 1099s.

Blended tax rate. The gains of commodity ETFs are taxed at a blended rate – 60% long-term capital gains and 40% short-term. This is an upside for short-term investors but a downside for long-term investors.

Currency ETFs

How currency ETFs are taxed depends on their structure.

For example, they could be taxed like equity ETFs, like commodities ETFs. If they’re structured as a grantor trust, they could be taxed at the income tax rate.

What Happens When an ETF Passes on Realized Gains?

A woman reviews when you have to pay ETF taxes.

While ETFs are incredibly tax-efficient, that doesn’t mean they’re tax-free.

Capital gains pass to investors when the underlying assets perform well. This is known as capital gains distribution. These are taxed at the long-term capital gains rate, even if you’ve held the fund for less than a year.

Capital gains distributions are typically made at the end of the year. You can reinvest them as shares in the fund or withdraw them. Regardless of whether you keep the distribution in the fund or pull it out, you will need to pay capital gains tax.

However, to help you avoid taxes, you could specifically invest in more tax-efficient funds that are less growth-focused.

How Dividend Payments Affect ETF Taxes

If you’re receiving dividend payments from your ETF, they’re are either taxed as ordinary or qualified dividends. Ordinary dividends are taxed at your income tax rate, whereas qualified dividends are taxed at the lower long-term capital gains tax rate.

Unless noted otherwise, dividends from your ETF are likely ordinary, as this is more common. Qualified dividends require you to hold them for a specific time period and must be unhedged, meaning they can’t be in use for puts or calls.

How to Minimize Taxes When Investing in ETFs

ETFs are generally more tax-efficient than mutual funds. However, there are still some tax strategies you can use to further reduce your overall liability.

Tax-Advantaged Accounts

One of the most effective is to hold ETFs in tax-advantaged accounts like traditional IRAs, Roth IRAs or 401(k)s. In these accounts, you either defer taxes until withdrawal with a traditional IRA, or you can avoid them altogether with a Roth IRA. This can shield interest, dividends and capital gains from annual taxation.

Tax-Loss Harvesting

If you’re investing through a taxable brokerage account, tax-loss harvesting can help reduce your bill. This strategy involves selling ETFs at a loss to offset capital gains elsewhere in your portfolio.

Be mindful of the IRS wash-sale rule, which disallows losses if you repurchase a substantially identical security within 30 days.

You can also consider investing in ETFs that are structured for tax efficiency. Broad market index ETFs and those with in-kind redemption structures (common in passively managed funds) tend to realize fewer capital gains.

Choosing funds that minimize turnover and avoid heavy dividend distributions can also reduce your taxable events over time.

How to Report ETF Income on Your Taxes

Most ETF investors receive a Form 1099-DIV, which reports dividend income and any capital gains distributions. Ordinary dividends are taxed at your income rate, while qualified dividends (if applicable) are taxed at the lower long-term capital gains rate.

When you sell ETF shares, you’ll receive a Form 1099-B from your brokerage. This form shows the proceeds, cost basis and gain or loss on your transaction. Gains on shares held for more than one year qualify for favorable long-term capital gains tax rates; gains on shorter-term holdings are taxed as ordinary income. Your holding period directly impacts which tax rate applies, so keep detailed records.

If you invest in certain ETFs, like those structured as limited partnerships (common among commodity funds), you may receive a Schedule K-1 instead of the standard 1099 forms. These require additional tax reporting and often delay filing.

To avoid surprises, review all tax forms your broker provides in early spring, and consult a tax professional if your ETF investments include complex structures.

Do You Owe ETF Taxes If You Don’t Sell?

Holding an ETF by itself does not trigger capital gains tax. Capital gains are generally recognized only when you sell ETF shares for more than your purchase price or when the fund distributes taxable gains.

However, ETFs can generate taxable income even if you never sell your shares. Many ETFs distribute dividends or interest income, which is taxable in the year it is paid, depending on whether the income is classified as ordinary or qualified.

Some ETFs also pass through capital gains distributions. These occur when the fund sells underlying securities at a profit and distributes those gains to shareholders. You may owe tax on these distributions even though you did not sell your ETF shares.

Reinvesting dividends or capital gains does not eliminate the tax obligation. The IRS treats reinvested distributions the same as cash distributions for tax purposes.

If your ETFs are held inside tax-advantaged accounts such as a traditional IRA, Roth IRA or 401(k), taxes on dividends, interest and capital gains are generally deferred or eliminated, depending on the account type.

Bottom Line

While ETFs are generally regarded as tax-efficient assets, there are scenarios where you’ll realize gains and losses. It’s helpful to know how ETF taxes come into play. The IRS applies different rates when you sell your shares depending on the ETF’s structure, the assets it contains and how long you’ve held it. If you’re receiving a capital gains distribution, the IRS will tax it at the long-term capital gains rate, no matter how long you’ve held it.

Tax Planning Tips

Certain ETFs are more tax-efficient than others. Creating a strategy to maximize your investment gains can benefit from the assistance of a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re going to have capital gains, it’s good to estimate ahead of time how much you’ll owe. See how the gains you make when selling stocks will be impacted by capital gains taxes by using this free capital gains tax calculator.
ETFs are a great option for beginners. They have low costs, can diversify your portfolio and are more accessible than other investment types. If you’re just getting started investing, check out our Investment Guide for Beginners.