Tax Planning | What to do with mutual funds at year-end

As we near the end of 2018, now is a great time to analyze the mutual fund holdings in your taxable accounts and take steps to avoid potential tax snares. Here are some helpful ideas for you to keep in mind.

Understand your capital gains

Capital gains are unavoidable on mutual funds by merely holding on to the shares. Near the end of the year, funds typically distribute all, or most of their net realized capital gains to investors. Regardless of whether you receive them in cash or reinvest them in the fund when holding mutual funds in taxable accounts, these gains are payable.

For each fund, find out how large these distributions will be and get a breakdown of long-term vs. short-term gains. If the tax impact is significant, consider strategies to offset the increase. One approach to save on tax would be to sell other investments at a loss.

Buy at the RIGHT time

Be smart enough to know that buying into a mutual fund shortly before it distributes capital gains and dividends for the year, is not equivalent to getting free money.  There’s a common misconception that investing before the ex-dividend date (the date by which you must own shares to qualify for distribution) is best.

In actuality, when you buy into the mutual fund the value of your shares immediately decrease by the amount of the distribution. So you will owe taxes on the gain without yielding a profit.

Sell at the RIGHT time

If you want to sell mutual fund shares that have appreciated in value, try waiting until just after year end so you can defer the gain until 2019 — unless you expect to be subject to a higher rate next year. In that scenario, you are better off paying the tax this year.

Understand that when you sell your shares, if you bought them over time, each block will have a different holding period and cost basis. To reduce taxes owed, select stocks for sale that have higher cost bases and extended holding periods, thereby minimizing your gain (or maximizing your loss) and circumventing higher-taxed short-term gains.

More than taxes…

Investment decisions are never solely driven by tax considerations alone. It is vital to know your priorities and overall financial goals. However, taxes should always be something you factor into your purchasing and selling decisions.

At CAPATA our team strives to help business owners clearly define and support them in reaching their goals. Contact us to discuss these and other year-end strategies for minimizing the tax impact of your mutual fund holdings.

CAPATA is a full-service accounting firm located in Laguna Niguel in southern California.

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