With Thanksgiving behind us and the New Year just a month away, many readers are starting to plan for April 15. If you’re an exchange-traded fund (ETF) investor, you’ve been lured to these investment vehicles in large part because most ETFs are extremely tax efficient. With the exception of inverse and leveraged ETFs–which deal with a special set of tax challenges because of their use of cash-settled swaps and forwards–most ETFs derive significant tax benefits from their creation units and redemption process.

As authorized participations buy and sell creation units (typically 50,000 shares of an ETF), an ETF manager will typically match those trades with basket shares that minimize tax liabilities for retail investors–essentially shifting the tax burden to institutional traders. Since most managers are mindful of the tax consequences of each trade, the majority of traditional ETFs distribute little or no capital gains to investors, making them far more tax efficient than a normal mutual fund. Because most ETFs are index-based products, trading is minimal and fewer gains are realized and passed along.

Nonetheless, investors always struggle to minimize their tax liabilities. I’m not a tax adviser and every investor’s tax situation is unique. But here are a few tips for reducing your obligation to the taxman.

Some investors have unrealized capital losses embedded in their portfolios from the dark days of 2008. Tax-loss harvesting is one option for minimizing the tax bill. Basically, long-term capital losses offset long-term capital gains, while short-term losses offset short-term gains. Carry forward capital losses can offset ordinary income by $3,000 a year, and excess losses can be carried forward until death. The IRS Wash Sale Rule says that investors can’t realize capital losses incurred by selling a stock if they buy a substantially similar security again within 30 days.

As I’ve noted before, ETF providers have begun competing head-to-head on cost and therefore have launched a number of similar products. This means that investors can sell a down position in an ETF and use the loss to offset other gains. One can then purchase another ETF that employs a similar strategy, or sell a single stock and replace it with a sector-focused ETF.

There are a few circumstances in which ETFs may come with hefty tax obligations. For example, interest distributions are taxed at a shareholder’s ordinary income rate just as with any other bond fund. Also, gains on physical metal funds such as SPDR Gold Trust (NYSE: GLD) and ETFS Physical Palladium Shares (NYSE: PALL) are taxed as collectibles rather than as equities. Consequently, gains are taxed at a maximum rate of 28 percent rather than at the current 15 percent rate for long-term capital gains. If you’re dead set against paying that higher tax rate, you should consider buying a mining-focused ETF or a resource fund that invests in equities rather than physical metals.

An ETF’s structure can also create problems for the tax-averse investor. The vast majority of ETFs are organized as registered investment companies, just like a traditional mutual fund. But a handful of specialty ETFs use other structures such as grantor trusts or limited partnerships. You’ll generally find that physical metals and commodity ETFs that use futures to build their portfolios employ these more specialized structures. Under these structures, shareholders must pay taxes on their share of the fund’s income and earnings each year, even if those dividends and earnings aren’t paid out. In other words, shareholders could wind up owing taxes on income they’ve never received. As a result, you should always read an ETF’s prospectus thoroughly to see how it’s organized.

The exchange-traded note structure is perhaps the most tax efficient of all. It’s a promissory note that holds no real assets so there aren’t costs associated with index rebalancing and typically no dividend or interest income. You’re only taxed when you sell.

Again, your tax situation is unique. Always consult a tax adviser when developing a strategy to mitigate your tax bill.

What’s New

The holidays are a slow season for new fund launches and no new ETFs have come to market in the past weeks.