> Typically, when you sell a stock for more than you paid, you owe tax on the gain. But thanks to a quirk in a Nixon-era tax law, funds can avoid that tax if they use the stock to pay off a withdrawing fund investor.
Later, when/if I sell the house, tax is due on the $50K in gains. Just like in the ETF case.
In the alternate treatment seemingly contemplated by the article, we could instead agree to sell one of the houses, jointly pay taxes on $50K in gains, and give me the sum of $150K-taxes, the gains of which I'd pay taxes upon again. You'd also have effectively paid taxes when you hadn't done anything but invest and hold. There's a pretty good argument this is unfair to me (to tax me twice on one gain); there's an almost ironclad argument that it's unfair to you.
It's no surprise that the treatment that is both more reasonable and more profitable is the one that ETFs seek to implement.
(Fees and other weirdnesses around real-estate ignored above for simplicity.)
The transfer price in gp’s example would be zero, wouldn’t it.
What probably happens is that I sell you my share in the holding entity for $150k, and the entity sells me the house for $150k.
There are cases where you could simply dissolve the entity and distribute the assets, which would avoid the sale and resulting taxes, in which case you’re just re-titling it and not selling it.
Tl;dr: this gets complicated really quickly.
It seems like the question here is how long you can delay taxes on a capital gain. It doesn't seem particularly unfair if you can't always delay capital gains tax as long as you like?
Company starts with $200K, held 50:50 by two shareholders, losslessly buys two house for that, those go to $300K, company losslessly sells one of them for $150K, company pays $20K tax on $50K gain, and then owns a $150K house and $130K in cash. Shareholder B sells their 50% share in the company to shareholder A for $140K cash, realizing a $40K capital gain on their original shares investment [incurring $16K in taxes on the gain in their shares]. Shareholder A now owns all the shares with a basis of $240K for a company value of $280K.
I argue that Shareholder B’s economic interest in a single gain has been taxed twice.
$10 of taxes deferred for 30 years at a modest interest rate of 2% puts an extra $8 in the investor’s pocket that should have gone to the government.
Edit: Though now that you mention it, I think I must've known this at some point in the past: that ETFs had preferential tax treatment. A while back, I moved my most recent investments to ETFs, even for the "same" fund (example: Vanguard Tech VITAX mutual fund vs VGT ETF) ...
Still, how are ETFs treated differently from a stock?
Think of it this way, if the fund paid these taxes when they sell their various holdings, that less tax amount would be baked into the ETF valution, which would carry over to a smaller tax bill when an investor sells their ETF shares and pays taxes.
That's still advantageous in many ways, but I think people in this topic are thinking this is some kind of complete tax avoidance. It isn't.
Why should they? They are not people.
When you buy an item for $50 at a store, as a consumer you would pay sales tax on it. But every transaction made from the buying of raw materials up to the time the store sold you the item is done tax free by the businesses, only at the time of sale to the final consumer, a tax is due.
Here ETF is kind of similar, except that the consumer provides the raw materials: A consumer buys the ETF at a share price of $100, and sells it once the ETF reaches $150: $50 should be taxable to the consumer. Instead of it being categorized as "sales tax" it's "income tax" or "LTCG tax", but the principle is the same.
If the institution made money off that transaction, by charging someone a $5 fee for instance, then tax should be paid on those $5 by the institution, but I don't see why amount the fund grew should have an impact. It goes both way obviously, if the consumer buys an ETF a $100 but sells it at $75, the institution should not be able to claim a loss on those $25, but that doesn't seem to be something claimed by the article.
The bank does not get hit with any capital gains due to the lower basis of the fund. The bank has their own basis in the shares that they brought into the fund which when traded for the other shares may trigger its own separate capital gain.
The shares the bank gets back at the end should have price equal to basis by that point I would think.