Mutual Fund Gains


L

Lenster

I am confused by the distribution of a long term capital gain I
received.
The following numbers are ficticious, but the ratios are correct.
In Aug of 2013 I purchased $3,000 of a mutual fund.
In December of 2013, I purchased another $5,000 of the same fund.
I was now holding a total of $8,000 in the same fund.
No capital gains were distributed in 2013.
By December of 2014, The fund value grew a total of about 3%

On December 12th, I received a Capital gain payment of $1,300.
This represents 16.5% of my investment which in no way is
representative of the growth which ocurred in the time I owned it.

My Broker totld me that the fund had not distributed a capital gain in
a long time and this was why it was so big.
The Capital gain is taxable and the amount is in no way representative
of my real gain which was more like $250.

Since the value of the fund was reduced by the amount of the
distribution, I was forced to sell all my shares so the loss would
offset the capital gain.

Can someone explain how a fund can do that?

Len
 
A

Arthur Kamlet

I am confused by the distribution of a long term capital gain I
received.
The following numbers are ficticious, but the ratios are correct.
In Aug of 2013 I purchased $3,000 of a mutual fund.
In December of 2013, I purchased another $5,000 of the same fund.
I was now holding a total of $8,000 in the same fund.
No capital gains were distributed in 2013.
By December of 2014, The fund value grew a total of about 3%

On December 12th, I received a Capital gain payment of $1,300.
This represents 16.5% of my investment which in no way is
representative of the growth which ocurred in the time I owned it.

My Broker totld me that the fund had not distributed a capital gain in
a long time and this was why it was so big.
The Capital gain is taxable and the amount is in no way representative
of my real gain which was more like $250.

Since the value of the fund was reduced by the amount of the
distribution, I was forced to sell all my shares so the loss would
offset the capital gain.

Can someone explain how a fund can do that?

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.
 
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S

scott s.

(e-mail address removed) (Arthur Kamlet) wrote in
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.
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.
...
 
L

Lenster

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
15% giving me the feeling I was being taxed on what was basically my
own money.
 
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B

Barry Margolin

Lenster said:
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
15% giving me the feeling I was being taxed on what was basically my
own money.
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.
 

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