Mutual Fund Gains

Quite easily, it seems.

When a mutual fund itself owns securities and similar property, it might sell some of those holdings at a gain. If the fund realizes a long-term capital gain, it can choose to pay income tax on that gain, often at higher rates than shareholders would pay if the gain was distributed to them, thereby lowering the NAV of the fund by the amount of tax that it would pay.

Or instead of paying tax on the gain, it can elect to distribute those long-term gains to shareholders, not pay income tax on the gains, and tranferring to shareholders the capital gain income.

As an individual shareholder, the capital gain distributed to you is taxed at a favorable tax rate.

Note this treatment applies only to long term gains. Any short term gains experienced by the fund are treated as ordinary income and are included as ordinary income, and shown as part of the ordinary dividends shown on your form 1099-DIV.

You can always choose to sell some shares at loss if you choose, but I would not think you were forced into that position.

Your broker's explanation that they had not distributed gains in some time is misleading. It might be true but not a good answer.

snipped-for-privacy@panix.com (Arthur Kamlet) wrote in news:m7mtia$ae2$ snipped-for-privacy@reader1.panix.com:

I think the concept of the "mutual fund" is that the fund itself pays no taxes; rather all the tax liability is passed to the share owners. IIRC the 1986 tax law created a new requirement that mutual funds distribute all long term capital gains within a certain timeframe so that the gains would be recognized by the share holders and taxed accordingly. Prior to this I think the mutual fund could simply retain the capital gains, which would be reflected in NAV at least for open-ended funds. So one consideration in buying actively managed mutual funds is tax efficiency (if owned outside of tax-advantaged accounts), as is purchase/sale timing (most LTCG distributions are done in December). For me tax consequences have led me to move from mutual funds to index-ETFs.

scott s. ..

Thanks for the responses.

I guess my major issue was that the fund only grew 3% in the time I woned it, but the long term capital gain I was hit with is closer to

This is a well-known caveat of mutual funds. It's called "buying a dividend".

The worst thing you can do is buy shares of a mutual fund the day before it makes a distribution. You'll immediately receive a distribution, and have to pay taxes on them.

In the case of capital gain distributions, it's not really so bad. The NAV of your shares will drop by the amount of the distribution. So when you eventually sell the shares, your capital gains tax will be less by the amount you paid this year (assuming capital gains tax rates don't change).

Dividends are where they really screw you. You'll have to pay tax at your full tax rate on this dividend, while the savings when you eventually sell will just be at the capital gains rate. But dividends don't accumulate from year to year like capital gains do, so they usually aren't as high.

You can look for "tax-efficient" mutual funds.