ETF and Mutual Fund Capital Gains, Taxes


If you are thinking you want to rebalance your investment portfolio or update it with some new investment ideas, the move could be costly if you do it now.

However, now is a good time to take advantage of harvesting any gains and offsetting them with selling securities or investments that have incurred losses.

As you go forward, keep in mind some of the tax traps related to buying mutual funds and exchange-traded funds (ETFs) at the end of the year.

A mutual fund is a collection of a very large quantity of other investments. For instance, a mutual fund may own hundreds of different stocks, as well as any number of other investments such as bonds. Mutual fund shares are bought and sold once each day at the end of the trading day.

Each year, a mutual fund (like any other investor) is responsible for income tax on the net capital gains it incurred over the year. However, instead of the mutual fund paying those taxes, each of the fund’s shareholders pays taxes on his or her share of the related gains. (Every year, the fund company sends each shareholder a Form 1099-DIV, which shows the individual’s portion of the gains.)
What makes the situation particularly odd is that, in any given year, the capital gains realized by the fund can vary (sometimes significantly) from the actual change in value or return of the shares of the fund.

For example, Aberdeen Asia-Pacific Fund (AAPEX), so far in 2011, has a negative return of almost 10 percent. Current shareholders will feel the added disappointment of paying tax on the fund’s gains this year. This fund pays approximately 36 cents per share in short term gains and 13 cents per share in capital gains on a current share price (as of this writing) of $17.32. If you recently invested $15,000 into this fund, you would wind up with a tax bill (assuming 35 percent federal and 5 percent Illinois state tax) of $141.60. That is almost 1 percent of your initial investment. If you wait until the “of record” date has passed, then you will not incur the tax penalty.

Another investment type to be aware of is ETFs, which are similar to mutual funds except their shares are traded throughout the day. Even though these funds are advertised as tax-sensitive, not all are, and uncommon situations do happen.
For example:

iShares Barclays Aggregate Bond Fund (AGG) just paid a distribution of 25 cents short-term and 8 cents long-term gain on a current share price (as of this writing) of $109.73. The total tax bill comes to a paltry $15.30, but it is worth noting as these funds do have to rebalance to stay in line with the indexes they are trying to follow, so purchases and sales do happen.

As with both a mutual fund and ETF, the fund’s capital gains can vary (sometimes significantly) from the actual change in value of the fund’s shares.

Disclaimer: This correspondence is for informational purposes only and does not constitute an offer or solicitation to sell shares or securities in the Stafford Wells Advisors or any related or associated company. None of the information or analyses presented are intended to form the basis for any investment decision, and no specific recommendations are intended. The Company expressly disclaims any and all responsibility for any direct or consequential loss or damage of any kind whatsoever arising directly or indirectly from: reliance on any information contained herein, any error, omission or inaccuracy in any such information or any action resulting there from.

Susan Carr-Templeton

About Susan Carr-Templeton

Susan Templeton is the founder of Stafford Wells Advisors, a wealth management firm serving individuals, families and businesses and advising workplace retirement plans. Stafford Wells was founded in 2008 with the mission of delivering independent, complete, unbiased investment and planning advice, free of any conflicts of interest. Susan Templeton has more than 20 years experience in investment management. She received her B.S.B.A. degree in marketing from the University of Denver and her M.B.A. from the University of Chicago. Susan is a trustee for the Advocate Foundation where she chair’s the Planned Giving Committee and is a member of the Investment Committee. Susan serves on the investment committee for the Visiting Nurse Association (Chicago) and is a former trustee of the Village of Oak Brook Police Pension Plan.