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Your Finance: Capital gains taxes on mutual funds

At the end of this year, many mutual

At the end of this year, many mutual funds are expected to distribute sizable capital gains to shareholders who will have to pay taxes on them. Photo Credit: iStock

If you are the kind of steadfast investor who buys a mutual fund and holds it forever, prepare to pay for your loyalty next April, when you settle up your 2014 tax bill.

At the end of this year, many mutual funds are expected to distribute sizable capital gains to shareholders who will have to pay taxes on them.

That is true of stock mutual funds that sold off last week after carrying forward big gains from 2013, and also may be true of the popular Pimco Total Return Fund, which was thrown a curve when star manager Bill Gross left Pacific Investment Management Co. in late September. The Pimco Total Return Fund was forced to sell appreciated bonds to pay off shareholders who left in his wake.

Mutual funds must distribute realized gains to their shareholders every calendar year. Managers of both bond and stock funds have seen sizable gains for several years running but have not had to sell shares and realize those gains. This year there have been some big sell-offs that may have forced the managers to sell winning securities and realize those gains for tax purposes.

Long-term gains are typically taxed at 15 percent; those in the top tax bracket face a capital-gains tax rate of 20 percent.

Note that none of this affects investors who hold mutual funds through tax-favored retirement accounts. They do not have to pay annual taxes on fund earnings.

For everyone else, here are some strategies that might help.

If you bought recently, you might consider selling quickly. If you have not seen much of a gain in a fund you bought, or if you have actually sustained a loss, you can sell shares and either use your capital loss to offset other gains, or at least get out before the gain is distributed. That strategy will not work if you have been in the fund long enough to rack up your own gains -- then you will just have to pay taxes on them when you sell.

Think before you buy. The people who will get hit hardest by these year-end mutual fund taxes are people who have not owned the funds for long. They buy in just before the distribution, miss out on the actual gains, but get hit with the taxable distribution anyway.

Do not buy any funds this year until you have checked with the fund company to find out when it is distributing 2014 gains. If you think it is a fund that is sitting on big gains, wait until that date passes before making your purchase.

Relax. At 15 percent for most people (20 percent for top tax bracketeers), the capital gains tax is still much lower than regular income taxes. And there are worse things than having to pay taxes because you made money.

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