A common question from mutual fund owners that we commonly receive during tax season is, “Will I have taxes due on mutual fund capital gains when I didn’t sell any shares of the fund?” The unfortunate answer is yes. In some cases, you will owe.
Capital Gains Distributions
If your mutual funds are held in a taxable account, you could wind up with a tax bill for capital gains and income distributions. You may still owe tax on these gains while automatically reinvesting capital gains and income distributions.
Tax Treatment of Mutual Funds
Mutual funds must distribute capital gains from selling appreciated securities and the income produced by the underlying securities held in the fund. As a mutual fund shareholder, you must pay the tax on those distributions unless you have losses in other investments that can offset the gains. Mutual funds managers estimate the distribution amount and the expected payout date on their websites in November/December. This information can help you plan for the tax you will owe and provide time to harvest losses in other investments to offset the tax due.
The NAV Price May Dip
A mutual fund’s NAV, or net asset value, might be lowered due to these distributions. NAV represents the value of a mutual fund and is calculated by adding the total value of the fund’s assets and subtracting its liabilities. Distributions of capital gains and income lower the fund’s NAV by the amount of the distribution per share. This adjustment does not directly impact the return that the fund generates. The return calculation includes distributions and the difference between the beginning and ending NAV.
Can I Avoid These Taxes?
There are ways to mitigate the tax on mutual fund distributions. The first strategy is to focus on which assets you own in qualified tax-deferred accounts such as 401(k)s and IRAs versus taxable brokerage accounts. Mutual funds that are not efficient due to historically high capital gains and income distributions are the best help in tax-deferred accounts. Investments in index and exchange-traded funds can be good choices for taxable accounts.
Tax loss harvesting is another tax mitigation strategy. Selling investments where your cost basis is higher than the current value will create a loss that can offset a gain, reducing the tax due. You can reinvest the cash made from the sale but be aware of the wash sale. The IRS requires a 30-day waiting period before you can purchase a similar investment after harvesting a loss.
Contact us
Please contact us if you have questions or need assistance with mutual fund capital gains and taxes. We look forward to speaking with you soon.