- Estimated distributions for some mutual funds exceed 30 percent of net asset value.
- 4 in 10 Americans have never sold an investment for a loss.
Don't celebrate your big market gains just yet – a tax bill is waiting for you.
Generally, mutual funds distribute capital gains to their investors near the end of each year. You can expect to see notifications from your fund companies now, and receive the gains in mid to late December.
These distributions are considered long-term capital gains, and generally are subject to a rate of 15 percent, depending on your income.
Expect to receive a Form 1099-DIV early next year with the details of your distribution. You'll need this when you file your taxes in the spring.
So far, 2017 is looking like a bumper year for the market. Consider that the S&P 500 index is up about 15 percent year-to-date. Even international stocks are enjoying a boom: The IShares MSCI Emerging Markets ETF has a year-to-date return of 31.6 percent as of November 14.
The topic has been front and center for financial advisors, who are finding ways to help clients save on tax bills from large mutual fund distributions.
"It's a big part of our annual meetings this time of year, especially in a year where we harvested lots of gains," said Debbie J. Freeman, CPA and director of financial planning at Peak Financial Advisors in Denver.
"We look for losses that we can take in clients' portfolios and determine whether mutual funds need to be sold before gains are distributed and then repurchased after," she said. "That's big this time of year."
Neither the House nor the Senate is touching the capital loss deduction in the GOP's proposed tax overhaul, so this tax saving strategy is still valid.
Here's where you can expect a large capital gains distribution and how you can reduce the tax pain.
What makes this year so interesting is that there aren't many places for investors to scoop up losses.
Morningstar compiled a list of the funds with the greatest exposure to capital gains, and they run the gamut from domestic companies to emerging markets.
Estimated distributions for some funds exceed 30 percent of their net asset value.
Scan your taxable accounts to see if you're holding any of these funds – and hold off on buying them prior to the distribution.
If you already hold a fund with a large expected distribution, here are a couple of steps you can take.
Consider selling some of your losing investments in order to offset taxes on capital gains and income.
You can deduct capital losses up to the amount of your capital gains, plus $3,000 if your losses are greater than than your gains.
If your loss exceeds $3,000, you can carry it forward into future years.
TD Ameritrade estimates that nearly 4 in 10 Americans have never sold an investment for a loss. "Taxes are among the places where regular investors are getting hit the hardest," said Lule Demmissie, managing director, investment products and retirement at TD Ameritrade.
Tax loss harvesting doesn't have to be a do-it-yourself project. It's a service that some custodians and robo-advisors are offering.
You can also work with your accountant and financial advisor to determine which of your assets might provide the best opportunity for losses.
If you're feeling generous, consider giving away your highly appreciated funds and taking a deduction for your charitable donation.
Generally, you can take a charitable donation deduction of up to 50 percent of your adjusted gross income. Gifts of assets that you bought cheaply and now have outsized appreciation make for better tax efficiency compared to cash gifts.
Enter the donor-advised fund. You can pour appreciated assets into one of these funds and make grants to charitable organizations.
You can front-load a donor-advised fund — that is, make a large gift of highly appreciated assets — take your charitable donation deduction now and make grants to your favorite causes over time.
"Front-loading the donor advised fund and using it to meet needs into the years going forward will mitigate some of the tax pain of these capital gains distributions," said Gavin Morrissey, managing partner at FSA Wealth Management in Needham, Massachusetts.
"It's amazing what we've seen in the markets, but it creates a lot of opportunities," he said.
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