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Blogging Beyond the Numbers

Own Mutual Fund Investments? Avoid These Tax Landmines
Posted by: Jamie Husemann 1 month ago

If you invest in mutual funds, be aware of some potential pitfalls involved in buying and selling fund shares.

Did you sell fund shares and not know it?

You may already have made taxable “sales” of part of your mutual fund investment without knowing it.

One way these surprise sales can happen is if your mutual fund allows you to write checks against your fund investment. Every time you write a check against your mutual fund account, you’ve made a partial sale or redemption of your interest in the fund. The partial sale may result in a taxable gain or a deductible loss when you write a check. Each sale is a separate transaction that must be reported on your tax return. The exception to this transaction is money market funds. Money market funds have a share value that remains constant,

Here’s another way you may unexpectedly make a taxable sale. If your mutual fund sponsor allows you to make changes in the way your money is invested, you could inadvertently make a surprise sale. For instance, let’s say a fund you are invested in isn’t performing well and you switch from one fund to another fund — making that switch is treated as a taxable sale of your shares in the first fund.  Any time you rebalance your mutual fund investments, you will trigger a sale.  Note: rebalancing mutual funds held within your retirement accounts (e.g., IRA or 401K) will not trigger a taxable sale.

Recordkeeping – What Statements to Save

Carefully save all the statements that the fund sends you. If you are not sure what to retain. we advise you error on the side of keeping everything. Be sure to keep official tax statements, such as Forms 1099-DIV, as well as the confirmations the fund sends you when you buy or sell shares or when dividends are reinvested in new shares. Without these records, it may be difficult to prove how much you paid for the shares, and thus, you won’t be able to establish the correct amount of gain that’s subject to tax or the amount of loss you can deduct when you sell.  In most cases, the mutual fund company will track basis for you; but you are ultimately responsible for maintaining the documentation.   

You also need to keep these records to prove how long you’ve held your shares if you want to take advantage of favorable long-term capital gain tax rates. Please note, if you get a year-end statement that lists all your transactions for the year, you can just keep that and discard quarterly or other interim statements. Be sure to save anything that specifically says it contains tax information.

Recordkeeping is simplified by rules that require funds to report the customer’s basis in shares sold and whether any gain or loss is short-term or long-term. This is mandatory for mutual fund shares acquired after 2011. Some funds will provide this to shareholders for shares they acquired earlier, if the fund has the information, but you can’t always count on this.

Timing Your Fund Purchases and Sales Can Defer Income & Minimize Tax

If you’re planning to invest in a mutual fund, there are some important tax consequences to consider in timing the investment. For instance, an investment shortly before payment of a dividend (or year-end capital gain distribution) is something you should generally try to avoid. Your receipt of the dividend (even if reinvested in additional shares) will be treated as income and increase your tax liability. If you’re planning a sale of any of your mutual fund shares near year-end, you should weigh the tax and the non-tax consequences in the current year versus a sale in the next year.

Identify Shares Sold – Not So Easy! 

If you sell fewer than all of the shares that you hold in the same mutual fund, there are complicated rules for identifying which shares you’ve sold. The proper application of these rules can reduce the amount of your taxable gain or qualify the gain for favorable long-term capital gain treatment.  You will have to work closely with your mutual fund company to see if they allow you to identify shares sold.   In some cases, once you adopt a method of tracking your basis within a fund, you’re stuck with it,

If you have questions or concerns on mutual fund reporting/transactions, please consult your Wegner CPAs tax advisor…preferably before you complete a transaction!

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