holiday presents wrapped

Capital Gain Distributions – A Holiday Gift I Wish I Could Take Back


It’s December –  that time of year when mutual funds give out capital gain distributions (whether wanted or not) to fund owners. These are distributions for gains realized within the fund, and they create taxable income for the fund owner. If you aren’t paying attention, they can create a sizeable, and unexpected, tax liability.

Many actively managed funds have experienced net outflows in 2016, and, since we’ve been in a bull market since 2009, managers have been forced to sell appreciated securities to pay for these liquidations. This triggers gain recognition that gets spread across a smaller owner base.

Generally, I try to avoid the potential tax bite by holding low-turnover index funds and individual securities in taxable accounts. That way, I can better control gain recognition – and tactically harvest losses.  Actively managed, high-turnover funds, if they have a place in a portfolio, are held in tax-sheltered accounts.

However, in some situations, it may be advisable to hold high-turnover funds in a taxable account. For example, a distribution to an individual in the 0% capital gain tax bracket may be a welcomed gain harvest. Or, a taxable account might be the only practical place to hold the fund, even if capital gains will be subject to taxation. In which case, I would determine if the funds are expected to distribute large (as a percentage of net asset value) gain distributions, and whether some proactive planning would be beneficial.

For instance, if a fund is expected to distribute a large capital gain, I would look for an alternative fund or ETF to substitute for the high-distributing fund prior to the distribution – if the sale itself won’t trigger an unwanted gain. If the high-distributing fund has already made the distribution, I would look to individual lots of shares purchased to see if I might be able to offset the gain with some losses.

A good resource for determining fund distributions is CapGainsValet. The free search option provides links to capital gain distribution estimates on about 70% of mutual fund assets.

Beware of the ‘gifts’ your mutual funds might be leaving you this month. They might be costlier than realized.

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