As 2018 comes to a close, it’s beneficial to review the mutual fund holdings in your taxable accounts and plan ways to avoid potential tax traps.
Avoid surprise capital gains.
Unlike with stocks, you cannot avoid capital gains on mutual funds by merely holding on to the shares. Funds typically most, if not all distribute of their net realized capital gains to investors near the end of the year. Holding your mutual funds in taxable accounts will cause these gains to be taxable to you regardless of whether you reinvest them in the fund or receive them in cash.
For each fund, get a breakdown of long-term vs. short-term gains and find out how large these distributions will be. If the tax impact is significant, think about strategies to offset the gain. For example, you could sell other investments at a loss.
Avoid buying into a mutual fund right before it distributes dividends and capital gains for the year. There’s a common misconception that investing in a mutual fund right before the ex-dividend date (the date you must own shares to qualify for distribution) is like getting free money.
In reality, the amount of the distribution immediately reduces the value of your shares. So you will owe taxes on the gain without actually making a profit.
If you are thinking about selling mutual fund shares that have appreciated in value, consider waiting until right after year-end so you can defer the gain until 2019—unless you expect to be subject to a higher rate next year. In that case, you would likely be better off recognizing the gain and paying the tax this year.
When selling shares, keep in mind that, if you buy them over time, each block will have a different cost basis and holding period. If you want to reduce your tax liability, it’s possible to select shares for sale that have longer holding periods and higher cost bases, thereby minimizing your gain (or maximizing your loss) and avoiding higher-taxed short-term gains.
Think beyond just taxes.
Tax considerations alone shouldn’t drive investment decisions. For example, think about your overall financial goals and your risk tolerance.
However, taxes are still an important factor to think about. If you would like to discuss these and other year-end strategies for minimizing the tax impact of your mutual fund holdings, contact us.
Ben R Shull CPA LLC provides clients with tax, transaction, and advisory services. The insights and quality services we deliver help lead our clients through the next generation of changes, and accelerate growth while reducing risk. CPA Katy, TX.