How do ETFs avoid capital gains?

ETFs don't "avoid" capital gains entirely, but many distribute fewer capital gains than many mutual funds because of in-kind creation and redemption. When large investors redeem, the ETF can deliver securities instead of selling them for cash, which can reduce realized gains inside the fund. (sec.gov)

That said, you can still owe capital gains tax when you sell your ETF shares for more than you paid, and ETFs can still distribute capital gains in some situations (for example, when the portfolio must sell holdings). (investor.gov)

So think of it as "often more tax-efficient," not "tax-free." The biggest drivers of your taxes are the account type you use (taxable vs retirement) and your own buy/sell decisions.