Are you investing in taxable accounts? Did your fund make a large distribution that was larger than your actual gain? Most investors think they have to bite the bullet, pay the taxes due using the experience as an expensive lesson. There is likely a better solution, however.
Let’s assume you purchased $10,000 of BCD fund in your taxable account on Dec 1st and the fund made a long-term capital gain distribution of $4,000 on Dec 3rd. Ouch! Unfortunately, there is nothing you can do about reporting the additional $4,000 in capital gains on your tax return. The good news is that you can sell the fund before the end of year and this will help the situation.
How does this work?
If you are reinvesting your distributions, the value of your holding will still be $10,000, but your cost basis is increased by the distribution you received. With a $14,000 cost basis- selling the fund will result in a $4,000 tax loss. The $4,000 long-term gain from the distribution is offset by the $4,000 loss on the sale. Ta da!
If you do not reinvest this distribution then the result is the same. In this scenario the BCD fund value is now $6,000, but your cost basis is $10,000. Selling will lock in the $4,000 loss. Ta da, again.
Selling a fund you just purchased isn’t ideal, but this strategy could help if you are in this unfortunate situation.
Some important factors to consider:
- This will not help much if the fund kicks out a short-term capital gain as these are reported differently – they are considered ordinary income and thus capital losses do not directly offset them.
- Selling a fund after a short holding period could result in some short-term trading penalties from your custodian or from the fund company itself. Check out these potential costs before trading.
- Is there an opportunity here to get a long-term gain from the fund and lock in a short-term loss? No – the IRS saw this coming. See Pub. 564 “Capital gain distribution before short-term loss” for details and an example.
(Disclaimer: Check with your tax advisor before executing any strategies mentioned on this site.)