A Year-End Surprise: A Tax Bill on Top of Your Mutual-Fund Losses
In this brutal year for markets, some mutual-fund investors are facing a double whammy: big losses and big tax bills. This is happening because fund managers have had to sell holdings to raise cash to pay investors leaving their funds. That often triggers payouts of taxable capital gains for investors who remain.
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This issue affects people holding mutual funds in taxable accounts rather than tax-deferred retirement plans such as IRAs and 401(k)s. Individual tax bills will vary, but some could be large. According to Mr. Wilson’s research, about 350 funds will pay out more than 10% of their net asset value this year, and more than 60 will pay out more than 20%. Many of these funds have double-digit losses for 2022. The 20-percenters include funds from familiar firms such as Morgan Stanley, Neuberger Berman, Pimco and J.P. Morgan.
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Here’s what’s behind the large payouts: By law, mutual-fund managers can sell holdings that have declined in value and save up capital losses to offset future capital gains on holdings that have risen in value. However, each year they must send current investors almost all net capital gains that aren’t offset by losses. After years of strong markets, many managers had few losses this year to offset gains on sales of winners. So when fundholders sold as markets tumbled, the managers often had to sell winners to meet redemptions—and the capital gains on the sales were then spread among remaining fundholders.
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Investors with mutual funds in a taxable account should check this year’s expected payouts and dates. Funds seldom send notifications, but they’re often on the fund’s website. Or call investor relations. Note whether capital-gains payouts are short-term or long-term. Also check your cost basis in the fund, which is often the purchase price plus any reinvestments. It’s the starting point for measuring your own gains or losses when selling fund shares. Often a good move for investors who want out of a fund in which they have net losses is to sell before the payout date.
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Both Mr. Wilson and Mr. Schultz often advise clients not to hold actively managed equity funds in taxable accounts because of the potential for large payouts, in both up and down markets. Better candidates for taxable accounts are passive investments in equities such as exchange-traded funds and index funds that seldom have large payouts.
https://www.wsj.com/articles/mutual-fund-capital-gains-distribution-11670546397 (subscription)