The Tax Hack Every Investor Should Know
IRS Code 852(b)(6) is the greatest tax hack that every investor should know. To learn more about how tax-efficient ETFs may add value to your portfolio, click Book A Meeting.
Investors in ETFs can defer capital gains tax on the underlying securities in the fund forever. This is because ETFs buy & sell positions using “in-kind transfers,” which are not taxable trades.
Obviously, when you sell your ETF investment, you pay tax on the gains in those shares. But if the fund sells individual securities at a gain, the taxes are not passed through to the individual investor, like they are in mutual funds.
At the end of 2022, when the 60/40 portfolio was down -18%, many mutual funds sent a big tax bill to their investors. "Why do I have to pay tax on an investment that lost money, and I didn't even sell my shares?" was a question I heard from many people in early 2023. The answer is because the portfolio managers sold positions within the fund that had appreciated over time, for cash, and those trades create taxes that are passed through to the owners of the shares. Some managers were forced to sell to meet redemption requests in the fund, and sometimes they were 'taking profits off the table' as they went to find the next great trade.
Simply put, section 852(b)(6) provides a tax hack that allows astute ETF investors to generate wealth more quickly through greater compounding of their investment gains.
