i've been reading about this and it sounds revolutionary and very negative for active mutual funds.

start simply with ETF's vs. mutual funds...... assume there's an ETF and mutual fund set up with $1B that just invests in SPY. no trading... SPY goes up 40%. $400MM gain for each. so an investor who owns 20% of each. and assume he redeems - terminology?? - his whole position.

with the mutual fund it sells 20% of the fund or $280MM, pays the investor that money and then passes on the $80MM capital gains to all its unitholders including the one who is redeeming

the etf just gives the redeemer 20% of the spy position. no tax effect for fund. now, does the redeemer owe tax either 1) immediately (year-end) or 2) when he sells.

i will note that the mutual fund can do same thing apparently but almost never do. i think sequoia fund did.

here's where i get confused,

1) apparently ETF can choose the securities package to give the redeemer. so they can give them the securities with the lowest tax basis.. it seems if redeemer has to pay taxes that's terrible for him i.e. he is paying taxes for far more than his 20% of fund.

2) i assume active ETF's pass along capital gains taxes for capital gains they actually incur i.e. made a killing on technology stocks and have now moved into oil stocks.

one thing i've never understood about mutual funds - at least those in canada. they seem to assign capital gains to holders of mutual funds at a certain time AFTER the capital gains are taken. that doesn't seem like your tax burden would necessarily match your economic exposure when the fund has owned long term winning positions they have sold recently and/or fundholder base has changed in last year....

sorry, a bit disjointed but i'm really interested in the ETF tax question - both basic redemption and tax and then active ETF's.

thx advance

i don't know a lot of these answers, but here's what i do know:

vanguard has a patent on letting their etfs and mutual funds share a pool of assets. they say it allows their mutual funds to be as tax-efficient as etfs are.

you can look up cap gains distribution history for various etfs. morningstar free has the last 4.5 years available - MTUM has over 100% annual turnover yet hasn't distributed any cap gains in that time.

the bogleheads wiki shows a longer history of some vanguard funds. it looks like the funds with equivalent etfs stopped distributing cap gains in 2002, and the ones without equiv etfs still distribute cap gains.
small cap value (has equiv etf) - no gainz since 2002
diversified equity (does not have etf) - gainz

not sure how they do this, it must be some trick with the creation/redemption process or loss harvesting.

as a regular old investor you don't redeem, you just buy/sell etfs and you don't owe taxes until you sell, (except for dividends, which you have to pay taxes for every year).