Last-Minute Tax Tips For ETF Investors

Dave Nadig of Index Universe writes: We talk a lot about the tax benefits of ETFs. Most of the time, what we’re talking about is the fact that few ETFs even make capital gains distributions, and even those that do tend to be quite small. That’s all true, and it’s because of the way creation/redemption works.

But there’s another thing that’s great about ETFs and taxes: They make taking advantage of losses extremely easy. And this year, it’s particularly interesting for investors with any interest at all in gold. Here are my top tips for ETF investors facing capital gains on their 1040 tax form come April. (I should point out that I am not a CPA, and if you have any concerns about your investment tax situation, do what I do and call an accountant.)

1. Harvest your gold losses immediately.

If you’ve been hanging on to, say, the SPDR Gold Shares (GLD | A-100) this year, you’re down a whopping 25 percent. If you have any capital gains at all, you should consider how you can use that loss to help offset your gains.

However, here’s the special thing about GLD and its ilk. All of the physical bullion ETFs are treated as collectibles, which means the maximum long-term capital gains rate is 28 percent. That’s terrible, when you have a gain. When you have a loss, it’s irrelevant. You can use that capital loss to offset capital gains (long term to long term, or short term to short term).

“But I don’t want to not be in gold!” I hear you cry. Well, here’s the other tricky thing. If you ask any certified public accountant, they will tell you that collectibles are not subject to wash-sale rules. In other words, you can technically sell gold in the morning, and buy it back in the afternoon, and it’s not considered a wash sale by the IRS. How is this possible? Because the rules for wash sales only apply to “securities.”

Now, here’s where it gets tricky. Nobody I talked to has ever seen anything definitive—from the IRS—on the tax treatment of bullion ETFs. So if you’re nervous about whether the IRS might change their minds on GLD versus gold bullion tomorrow, you have other options.

First, you could replace your bullion exposure with futures exposure in the short term. The PowerShares DB Gold ETN (DGL | B-46) is a perfectly fine short-term substitute, and correlates at .99 to the price of gold. Long term, it has tax and expense downsides, but short term, you’ll avoid any issues on wash sales and still keep your exposure.

Of course, you could also change teams, as it were, and choose the Market Vectors Gold Miners ETF (GDX | A-54). Despite being equities, it correlated at .98 to gold on a day-to-day basis, so it would certainly give you some exposure to any surprise January gold rally, and there are additional reasons to consider it a valid flyer.

2: Look for other widely held losses and find wash-proof alternatives.

This is the inverse case if you’re one of the investors who holds part of the $6 billion GDX. If you’re sitting on that 50 percent loss for the year, now’s the time to pull the trigger. You could swap into a bullion ETF, of course, or you could swap into the more-than-suitable alternative, the iShares MSCI Global Gold Miners ETF (RING | B-99), which is actually our analyst pick in the space.

But it doesn’t just have to be enormously dramatic to be helpful to your tax situation. Consider the most widely held emerging market ETF, the iShares MSCI Emerging Markets ETF (EEM | B-100) and the Vanguard FTSE Emerging Markets ETF (VWO | B-85). Between the two funds, $90 billion of investor money is sitting on losses of between 3.4 percent (EEM) and 4.6 percent (VWO).

Why not take those losses on the chin and use them to offset gains, all while perhaps swapping into our preferred fund in the space, the iShares Core MSCI Emerging Markets ETF (IEMG | B-98). You may be able to save yourself substantial expenses next year in the bargain (18 bps versus 69 bps in EEM, although still 18 bps in VWO).

And fixed income is rife with losses this year as well. Consider investors in the iShares 20+ Year Treasury Bond ETF (TLT | A-72). TLT holders are down more than 14 percent in 2013 year-to-date. While there’s no 100 percent direct competitor to that ETF, the SPDR Barclays Long Term Treasury ETF (TLO | B-88) provides extremely similar yield, maturity and duration, and certainly would cover any rally for a month.

Again, you’d also be swapping into the fund that’s our analyst pick in Long Term Treasurys, so you consider this an opportunity to upgrade to what’s arguably a better fund, while using those bond losses to offset, perhaps, some equity gains.

And let’s be clear—you’ve probably got equity gains. While various international ETFs struggled this year, the worst-performing U.S. equity ETF in our analytics system is down only 4.17 percent in the past 12 months as I write this—the SPDR S&P Metals and Mining ETF (XME | A-53), which suffered right alongside the global miners. In fact, of the 360 U.S. Equity ETFs we track, only five have negative 1-year performance, all focused either on REITS or miners.

So what about the winners? Oftentimes taxable investors are reluctant to book their gains for fear of the tax man, and this can overwhelm common-sense rebalancing of positions.

If you were a crystal-ball-gazing genius who put 20 percent of your portfolio into the PowerShares Nasdaq Internet ETF (PNQI | B-72) one year ago today, well, that fund’s 67.4 percent gain means your 20 percent is likely a whole lot more like 30 percent now. Perhaps it’s time to take a little off the table?

The beauty of using ETFs in a diversified portfolio is that come tax time, a little portfolio work can make an already-tax-efficient investment even more tax efficient. You just have to be willing to make a few trades.