From Wall Street’s Best Editor Nancy Zambell: Many investors are often confused by mutual fund distributions at the end of the year. I hope this article by Janet Brown of NoLoad FundX will clarify some of your questions.
Many stock funds will distribute capital gains and income this month. Even though the stock market and many stock funds are flat or down this year-to-date, quite a few funds are planning to make big payouts this month. Fortunately, most funds are expected to pass along mostly long-term capital gains, which are taxed at a lower rate than short-term gains or income. These distributions are only taxable if you own funds in a taxable account; if you own funds in a tax-deferred account, you needn’t worry about the tax consequences of distributions.
Year-end Tax Tips
For our clients, we harvest losses when possible because these losses can be used to offset gains realized this year, and losses can be carried over and used in future years, too. We also try to
avoid buying into a fund that expects to make a big taxable distribution this month.
What to Know Before You Trade This Month
You’ll want to find out if your funds are expected to distribute, so check directly with the fund company. Many fund companies provide estimated year-end distribution information on
their websites.
Record Dates & Ex-Dates
The ex-date is the date that the fund’s NAV drops by the amount of the distribution. But you may want to consider a fund’s record date (which may be the same as the ex-date or within a few business days of the ex-date) because the record date determines whether you are eligible to receive a fund’s distribution. If you are a shareholder in a fund on the fund’s record date, you will receive the fund’s distribution either in cash or reinvested in new shares. Record dates are typically available on a fund’s website.
What To Do If A Fund You Own is Making a Distribution
If you own a fund making a distribution, you have three options:
1. Hold the fund and receive the distribution;
2. Sell the fund before the record date to avoid the distribution;
3. Sell the fund after the distribution.
Which option is best for you? It depends on the amount of gain or loss you’d realize if you sold your shares compared to the amount of the fund’s distribution and how much of that distribution is long-term gain, short-term gain or income. Here are three examples:
1. Hold Funds & Receive the Distribution
If you’ve held a fund less than 12 months and have a significant gain, you are probably better off holding the fund and receiving the distribution, especially if the fund is distributing long-term capital gains or the total distribution is less than 1% of the fund’s NAV.
2. Sell a Fund & Avoid the Distribution
Generally the only time it pays to sell a fund prior to a distribution is if the fund is low ranked; you have a long-term capital gain that is similar in size to the fund’s distribution; and the distribution includes short-term gains or income.
3. Sell the Fund After the Distribution
There are times when it can be beneficial to sell a fund after its distribution. A fund’s NAV drops by the amount of its distribution, and when you reinvest the distribution in new shares, the amount of the distribution becomes part of your cost basis. By selling the fund at a lower price, you may be able to realize a capital loss that you can use to offset other gains. You also may be able to convert what would have been a short-term capital gain into a long-term capital gain.
If you take the distribution and then sell the fund, you’d likely be selling the fund at loss, and you could use that loss to offset other gains. Remember that if you’re selling a fund at a loss, you’ll have to consider the “wash sale” rule, which states that if you sell a fund to realize a loss, you can’t buy the fund back within the next 30 days. If you do buy back into the fund, the loss can’t be used to offset gains.
And if you sell a fund in a taxable account this month, make sure the funds you buy have already made their distributions.
Janet Brown, NoLoad FundX, www.fundx.com, 800-763-8639, December 2015
