Key Takeaways
- Only 6% of US exchange-traded funds surveyed anticipated any capital gains distribution in 2025, and just 2% expected amounts above 1% of net asset value.
- The 10 largest distributions were mainly tied either to markets restricting in-kind transactions or to strategies using swap contracts.
- The alternative and nontraditional equity US categories clocked the highest share of ETFs estimating gains, due to derivative-heavy strategies.
ETFs proved their tax efficiency, once again, in 2025. Morningstar surveyed 15 of the largest US ETF providers and roughly 1,600 US ETFs, gathering estimated capital gains data for 2025. Only 6% of the ETFs surveyed estimated a capital gains distribution, and only 2% estimated a distribution greater than 1% of their NAV. The exhibit below summarizes capital gains distributions for some of the largest ETF providers.
Why Capital Gains Distributions Matter
Capital gains typically happen on two different levels in ETFs and mutual funds. Investors or their advisors control the first level. They determine when to buy or sell ETF or mutual fund shares and owe capital gains taxes if those shares have appreciated in value.
They have less control over the second level. Mutual funds or ETFs generate capital gains when their managers sell stocks, bonds, or other assets at a gain with no offsetting losses. By law, mutual funds and ETFs must distribute those gains to their investors, and the distributions are paid out proportionally to all investors in a fund.
Investors holding funds in taxable accounts will need to pay Uncle Sam on those distributions, assuming they have no offsetting losses. Those distributions are taxed just like normal capital gains. The long- or short-term classification of those distributed gains depends on how long the fund held the assets, not how long the investor held the fund.
Why Do ETFs Have a Tax Advantage Over Mutual Funds?
ETFs usually use in-kind redemptions to avoid distributing capital gains. Instead of selling an asset for cash, like a mutual fund does, ETFs can exchange their appreciated assets in-kind with specialized market makers. These transactions allow an ETF to get rid of appreciated assets without having to sell those assets at a gain.
In 2024, roughly 40% of US mutual funds paid out capital gains, compared with roughly 5% for US ETFs. The average ETF capital gains distribution was more than a percentage point less than the average distribution paid by mutual funds. In other words, fewer ETFs distribute capital gains than mutual funds, and, if an ETF does, its distribution is likely smaller. That’s a win for ETF investors, and the trend continued in 2025.
When ETFs Pay Capital Gains
ETFs can usually get around capital gains distributions, but not always. The chart below shows the ETFs estimating the largest distributions in 2025.
Some countries, like India, don’t allow in-kind transactions. So, those ETFs, like iShares India 50 ETF INDY and Invesco India ETF PIN, often pay out large capital gains distributions. Brazil, China, South Korea, and Taiwan don’t allow in-kind transactions either, which is why international ETFs like WisdomTree True Emerging Markets ETF XC estimated higher distributions for 2025.
Some security types—especially illiquid, customized, or complex securities—often cannot be traded in-kind. In those cases, ETFs may have to sell positions for cash and incur capital gains. Derivatives are a prime example of securities that typically can’t be exchanged in-kind. For example, ProShares Ultra Financials UYG uses swap contracts to achieve its goal of 2 times the daily performance of the S&P Financial Select Sector Index. Swap contracts are customized and aren’t traded on exchanges, so they’re typically settled with cash.
Nearly all the ETFs landing in the top 10 of estimated capital gains distributions either had exposure to countries restricting in-kind transactions or held swap contracts. JPMorgan Fundamental Data Science Large Value LVDS was the one exception. JPMorgan converted LVDS into an ETF from a mutual fund in July 2025. Its estimated capital gains distributions are likely gains incurred when it was a mutual fund.
Distributing Categories
The alternative and nontraditional equity US category groups stand out in the exhibit below for the percentage of ETFs estimating capital gains. These categories include ETFs that frequently use derivatives to achieve their targets, which often cannot be traded in-kind. ETFs in these categories tend to have higher and more frequent capital gains distributions.
Historically, the municipal- and taxable-bond categories have had the highest proportion of ETFs paying out capital gains, from 2020 through 2024. However, the distributions in those categories tended to be lower on average. Bonds typically incur capital gains only if they are sold (or called away) above their par value. While bonds can be traded in-kind, it’s not always practicable because the market is fragmented, and liquidity varies, so ETFs sometimes use cash redemptions instead, which can trigger capital gains.
Check out last year’s article here.