Because exchange traded funds (ETFs) offer a dynamic product that can serve as a buy-and-hold or buy-and-sell investment, they can offer investors the opportunity to reap long-term or short-term gains. Knowing the difference between the two is crucial, especially when it comes time for taxes.
When investors sell an asset for a profit, the Internal Revenue Service (IRS) denotes this as a capital gain and vice versa for a loss. Investors should be cognizant of both because taxes are owed on a capital gain and income could be offset with a loss.
For capital gains, there’s more discernment to determine the tax owed: whether the gain was short- or long-term. This is due to the various tax rates applied to short-term gains versus long-term gains, which also involve other factors such as tax brackets based on income.
Quite simply, a short-term gain is a capital gain attained if an investor buys and subsequently sells the asset within a year. Conversely, a long-term capital gain is where an investor buys and then sells an asset held for longer than one year.
A day trader who purchases shares of an ETF and sells it within the hour to extract a profit is an example of a short-term capital gain. An investor who buys and holds a bond ETF for three years and then subsequently sells it, will be subjected to a long-term capital gain.
