Friday, November 28, 2008

You may be in for a big surprise

It happens after every down year in the stock market. I start getting calls in February asking; how did I lose X amount of money in my mutual funds but still have to pay long and short term capital gains?

The answer is how mutual funds work. First you can buy and sell the fund and the fund manager can buy and sell stocks within the fund. You buy ABC mutual fund for $10 a share and by the end of the year it is $6 a share. If you never sell your shares you do not realize the loss, which means you can not deduct it on your return. The fund manager of ABC buys a stock for the fund and decided to sell it before the end of the year for a big gain. Unless the fund manager sells another stock at a loss, the capital gain will be passed on to you. You will have to report this gain and pay taxes on it.

What you can do.
Call your mutual fund company or go to their website and ask/look for the estimated short and long term capital gains. If the fund is going to pay a large capital gain and you have a large loss you may want to consider selling the fund so you can write off the loss and not have to pay taxes on the internal gains. It is important that you get out of the fund before the record date. If you own the fund on the record date you will receive the distribution.

If you would like to get back into the fund you need to beware of the wash sale rule. The wash sale rule states that you can not claim the loss of an investment when the same investment was purchased within 30 days before or after the sale date. This simple means you need to wait 31 days to buy it back.

You also want to consider if the fund is closed to new investors. If you sell you may not be able to get back in. Also if you are in funds with sales loads, you want to check the cost of selling and what happens if you want to buy back in. Most likely you will have to pay the load again.

Selling a fund to take advantage of the loss is something that you should consider only after talking to your tax preparer and your financial advisor.


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