As has been widely noted, one of the primary reasons so many smart market participants, including advisors, flock to exchange traded funds (ETFs) is superior tax efficiency relative to mutual funds.

One of the areas in which that’s consistently born out is capital gains. A quick refresher: There are two kinds of capital gains taxable events. There’s the “good” kind. That’s when an investor sells a profitable position in a taxable account. Then there’s the “bad” variety, or when a fund manager sells all or a portion of a winning position. In that scenario, the tax obligations are passed onto the fund’s investors.

The vast majority of ETFs, even the ones that are actively managed, don’t distribute capital gains. In any given year, it’s typical for most ETF issuers to tell advisors and investors that 95% or more of their products didn’t distribute capital gains for that year. Those lofty percentages are annual occurrences, confirming the tax benefits of ETFs.

It happened again this year. New data from Morningstar indicates just 6% of US-traded ETFs will subject investors to capital gains this year and of that group, just 2% will exceed 1% of the funds’ net asset values.

Inside ETF Cap Gains Data

To arrive at the aforementioned cap gains conclusions, Morningstar evaluated 1,600 ETFs from the 15 largest issuers – group including BlackRock, Vanguard, State Street, Schwab, Fidelity, Capital Group and WisdomTree, among others.

The research firm points out that the 10 worst ETF offenders in terms of 2025 cap gains distributions, the commonalities are exposure to international markets prohibiting in-kind transactions or deployment of derivatives-based strategies. The point about in-kind transactions is crucial.

“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,” notes Morningstar. “These transactions allow an ETF to get rid of appreciated assets without having to sell those assets at a gain. ”

Put simply, ETFs, even the actively managed ones, use in-kind transactions, but that’s not luxury afforded to mutual funds. That also may be one reason why so many active open-end mutual funds are being converted to the ETF wrapper. At the very least, issuers know that end users, including advisors, like low fees and the tax benefits that are native to ETFs.

With Tax Efficiency, ETFs Just Keep Winning

As noted above, 2025 is old hat for ETFs on the minimal capital gains distribution front. It is unlikely 2026 and any year thereafter will be any different and that’s a plus for advisors and clients. After all, Uncle Sam isn’t additive to total returns. He subtracts from them.

“In 2024, roughly 40% of US mutual funds paid out capital gains, compared with roughly 5% for US ETFs,” concludes Morningstar. “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. ”