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Year End Capital Gains

December 11, 2017

As the end of the year approaches, now is a good time to start thinking about capital gains. This year, many segments of the market experienced very nice gains.  If capital gains are distributed outside of qualified accounts, (IRA’s Roth IRA’s, 401k’s, TSP’s, 403b’s) you most likely will have to pay income tax on them. So, what are capital gains and how much taxes do I have to pay?

Capital gains occur when you sell all or part of an investment for more than your bought it for.  This can occur when you sell rental property, collectables such as gold coins or fine artwork, or most commonly, securities (stocks, bonds, mutual funds). Generally, you choose when you sell a hard asset such as real estate or collectables and also the actual sale of your individual securities.  However, you do not have this control over the investments inside mutual fund. 

Most often with mutual funds, fund managers buy and sell assets within the fund portfolio throughout the year.    The gains and losses are netted and if there is a gain, it is passed on to the investor, usually right before the end of the year, as a distribution. Be aware that not all mutual funds will pay out capital gains in a year.  If capital gains are issued by a taxable account, the investor must pay tax on the distribution even if the money is reinvested back into the same fund.  This reinvested distribution adds to the basis of the account, which is the amount you have invested. Thus, you are paying the tax on the gain now, which should reduce the tax you will have to pay later.  In the late nineties and early two thousands, some mutual funds distributed very large capital gains and investors were surprised by some very large tax bills and sometimes even underpayment of tax penalties.

If you have a fairly large amount invested in taxable mutual funds, it might be prudent to check with the mutual fund website to get an estimate of how much of a capital gain is likely. Be aware, some mutual funds distribute capital gains more often than annually.  Some funds distribute short term capital gains as well.  The short-term gains are taxed as ordinary income, while the long-term gains are taxed at the long-term rate, which for most people, is 15%.  However, if you are in the highest federal tax bracket of 39.6%, you will likely pay 23.8% on the long-term gain. If you decide to sell any securities at a loss to off set some of your capital gains, it needs to be done no later than December 27 to make sure everything is posted by the end of the tax year.