Exchange-Traded Funds (ETFs)

Securities, commodities, and precious metals ETFs use different structures, and tax treatment varies.

Securities, commodities, and precious metals ETFs use different structures, and tax treatment varies.

Securities ETFs usually are regulated investment companies (RICs). Like mutual fund RICs, securities ETFs pass through their underlying ordinary and qualifying dividends to investors. Selling a securities ETF is a sale of a security, calling for short- and long-term capital gains tax treatment using the realization method. A securities ETF is a security, so wash-sale loss adjustments or Section 475 apply if elected.

Commodities/futures ETFs. Regulators do not permit commodities/futures ETFs to use the RIC structure, so they have usually structured as publicly traded partnerships (PTPs). Commodities/futures ETFs issue annual Schedule K-1s passing through their underlying Section 1256 tax treatment to investors and other taxable items. Selling a commodities ETF is a sale of a security and calls for short- and long-term capital gains tax treatment using the realization method. Wash-sale loss adjustments or Section 475 apply if elected because a commodities ETF PTP is widely held.

Taxpayers invested in commodities/futures ETFs may need to make cost-basis adjustments on Form 8949 to capital gains and losses, ensuring they don’t double-count the Schedule K-1 pass-through items. For example, if the K-1 passes through Section 1256 income to Form 6781, the taxpayer should also add that income to the cost basis on Form 8949. Otherwise, they will double count the income, causing an overstatement of tax liability. Form 1099-Bs and trade accounting programs do not make these cost-basis adjustments from K-1 income/loss, so adjust Form 8949 accordingly.

Master limited partnerships (MLPs) are PTPs issuing Schedule K-1s to investors with pass-through income. Purchasing a PTP that has business dealings, such as oil and gas operations, in a retirement account will probably cause unrelated business taxable income and tax (UBIT) and Form 990 filings since the K-1 passes through business income. See our blog post, Retirement Plan Investments in Publicly Traded Partnerships Generate Tax Bills, https://tinyurl.com/retirement-ptp.

Physically backed precious metals ETFs. These ETFs may not use the RIC structure either. Although they could use the PTP structure, they usually choose the publicly traded trust (PTT) structure (also known as a grantor trust). A PTT issues an annual Schedule K-1, passing through tax treatment to the investor, which, in this case, is the “collectibles” capital gains rate on sales of physically backed precious metals (such as gold bullion). Selling a precious metal ETF is selling precious metal, which is a collectible. If a taxpayer holds collectibles over one year (long-term), sales are taxed at the “collectibles” capital gains tax rate — capped at 28%. (If the ordinary rate is lower, use it.) That 28% rate is higher than the top long-term capital gains rate of 20% (2022 and 2023). Short-term capital gains use the ordinary tax rates. Physically backed precious metals ETFs are not securities, so they are not subject to wash-sale loss adjustments or Section 475 if elected. (For more information, see our blog Tax Treatment for Precious Metals at https://tinyurl.com/rrmbg87, which includes a discussion on all sorts of precious metal ETFs.)

For more information, see Green’s Trader Tax Guide.