If you are a mutual fund investor, chances are you will receive a capital gain distribution notice in the next few weeks. Distributions represent your share of gains the fund earned when it sold investments. While gains are welcome, the taxes on them are not. Since gains are a form of income, they’re taxable to you. The exception: Taxes on distributions from mutual funds you hold in a retirement plan won’t be due until you begin taking money out of those accounts.
Capital gain can still occur even if the fund has performed poorly. This happens when a fund manager sells stocks that may be down for the year but that have increased in value since their purchase, resulting in a net capital gain. The trend of fund managers to trade holdings frequently in an effort to increase their fund’s return adds to the likelihood that you’ll owe capital gains tax.
In most cases, capital gain distributions from mutual funds held in taxable accounts are taxed as long-term gain, even for investors who have held a fund for less than a year.
Here are a few ways to reduce the taxes on capital gain distributions:
Offset gains with capital losses. Losses from one investment may be used to offset capital gains from another, dollar for dollar.
Consider tax-efficient funds. A fund that holds its investments is less likely to generate taxable gains than a fund that buys and sells assets frequently. Before you buy, consider the types of investments a fund holds and the fund’s investment philosophy.
Don’t buy a fund immediately before it makes a capital gains payout. You’ll essentially get back a part of your investment in the fund and be taxed on it. Wait until the distribution has been made.
For more information, please contact Theresa M. Stewart at 661-775-9534.