ETFs can be more tax-efficient compared to traditional mutual funds. In general, holding an ETF in a taxable account will result in fewer tax liabilities than if you had an investment fund of a similar structure in the same account. From the IRS perspective, the tax treatment of ETFs and mutual funds is the same. Most currency ETFs come in the form of grantor trusts.
This means that the benefit of the trust creates a tax liability for the ETF shareholder, which is taxed as ordinary income. They don't receive any special treatment, such as long-term capital gains, even if you hold the ETF for several years. Since currency ETFs are traded in currency pairs, tax authorities may assume that these trades take place over short periods of time. ETFs can be considered a little more tax-efficient than mutual funds for two main reasons.
One, ETFs have their own unique mechanism for buying and selling. ETFs use building blocks that allow the buying and selling of assets in the fund collectively. Second, most ETFs are passively managed, which in itself creates fewer transactions because the portfolio only changes when there are changes in the underlying index it replicates. Investors should keep in mind that while ETFs are very tax-efficient, they can sometimes distribute capital gains.
The main purpose of indice-based ETFs is to track the target index as closely as possible. Maintaining fiscal efficiency is another important goal for Vanguard portfolio managers, but that is ultimately one of multiple secondary objectives including managing transaction costs and adding the relative benchmark value that Vanguard balances for the benefit of our diverse base of shareholders. As with individual securities, when you sell shares in an investment fund or ETF (exchange-traded fund) for profit, you will owe tax on that realized gain. Capital gains that are on paper only because the investment has increased in price since the original purchase, but has not yet been sold for profit.
In terms of capital gains and losses and dividends, tax law treats them the same way for ETFs and mutual funds. However, one of the benefits of ETFs is that they often face fewer taxable events. The IRS treats such ETFs in the same way as an investment in the metal itself, which for tax purposes would be considered an investment in collectibles. This means you can't take advantage of normal tax rates on capital gains on ETF investments that invest in gold, silver, or platinum.