Q I've been hearing a lot about exchange-traded funds lately. How are they different from mutual funds? Should I consider them as a long-term investment?
Tim Armato, Minneapolis
An exchange-traded fund (ETF) is basically an open-end mutual fund, which tracks an underlying index (such as the Standard & Poor's 500), but they are traded like a common stock on an exchange. ETFs are similar to mutual funds in that they purchase a basket of companies to track an array of market indices.
ETFs are definitely an option for long-term investments. One thing to be aware of is that since they are traded like stocks, there are transaction costs associated with each purchase or sale, so it might not make sense to buy small amounts on a monthly basis.
Brad O'Keefe (27)
Q Can you explain how capital gains work for house sales? Does it change if it's your residence or rental property?
Scott, St. Paul
Current tax law allows an individual to exclude $250,000 of capital gain on the sale of a home if he or she meets both the "ownership test" and the "use test." The exclusion amount is doubled to $500,000 for married couples filing jointly.
Under the "ownership test," an individual must have owned the dwelling for at least two of the past five years. For married couples, just one of the spouses must meet the "ownership test." The "use test" states that an individual must have lived in the dwelling for at least two of the past five years. For married couples, both spouses must meet the "use test."
The exclusion also can be used for rental property as long as the ownership and use tests are met. However, the gain equal to the depreciation claimed for renting the house cannot be excluded.
The IRS Web site, www.irs.gov, provides an excellent review of the laws; search for "Publication 523."
Brad Forester (32)