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Watch out for Taxes on your Mututal Fund Distributions!
from: John GrothMutual Funds: Be Aware of Taxes on Distributions!
With the Christmas holiday just around the corner many are looking for surprises under the tree.
One surprise you should be aware of before the year ends are capitals gains on mutual funds-especially taxable mutual fund accounts. Capital gains in mutual funds results in the fund’s sales of assets during the plan year. If the profit on asset sales exceeds losses, the fund must distribute the profits to shareholders once a year, usually in December. Losses are not passed through and are used to offset gains within the fund and may be carried forward up to eight years.
Many close observers of the mutual fund industry believe distributions this year could set records. So if you are thinking of buying a fund that is projected to post a big gain, you may want to wait until after the distribution date.
If you buy the fund before the distribution date you will be required to pay capital gains taxes on the distribution. The funds price will go down equal to the distribution so if the market drops and the shares stay down through next year you could face paying for the distribution on your 2007 taxes while having a loss for next year.
Also, if you have a fund that is paying a big distribution before the end of the year and you plan on selling it may be a good idea to sell before the distribution. This way you avoid the extra capital gains from the distribution along with any gain you have from the sale.
Capital gains from mutual funds can include both long and short term gains. The long term gains results from assets owned a year or more and are taxed at a favorable rate, 15% for most investors and 5% for those in the 15% or 10% tax brackets. Short term gains are taxed as ordinary income and the tax rate depends on your tax bracket and could be as high as 35%.
Since the fund statements don’t come out until in January you could go to the funds web site or call their customer service line and find out the estimates of the distributions. They can also tell you the dates the fund expects to make the distribution.
Another way to reduce your tax bite is to examine your portfolio and determine if you have losses in other investments. If appropriate you can offset gains in your funds by sell some of the losses.
One group of mutual funds that fully participate in the market but normally pay small capital gains are index funds. They are structured to mirror selected stock indexes so their stock trading is often much less than other funds. They also have very low management fees-which is another benefit to shareholders. Many mutual fund families offer some form of indexing funds. You also might look at tax managed funds and tax exempt bond funds for further tax benefits.
So you have a little time to make sure you don’t get surprised this year by capital gain distributions from your taxable mutual funds. Going into next year it will be something to be aware of as you manage your investments.
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