Bregman recommends looking at a fund's financial statement, where asset details can provide a snapshot of possible shareholder tax costs. For example, a fund with net assets of $109 billion reports that $56 billion of that comes from shareholder purchases and $50 billion from the fund's unrealized appreciation.
"That tells you right there that almost half the net asset value is appreciated gain," he explains. "It doesn't necessarily mean you'll get hit with a tax distribution, but you could."
Taxes now help reduce taxes laterBregman concedes that most investors, however, aren't likely to go to this trouble. And in the greater investing scheme of things, maybe they really shouldn't worry about the taxes.
"If you talk to a financial planner," says Bregman, "he'll ask 'What's the big deal?' All the distribution does is increase your cost basis."
Why does that matter? Because even the IRS won't make you pay taxes on the same investment twice.
The taxes you pay on reinvested capital gains distributions throughout your ownership of a fund can be used to increase the fund's cost basis -- the initial cost of an investment plus costs incurred while you own it. You use the basis when you sell your total holdings to figure what portion of the sale is taxable.
For example, if you bought 1,000 shares of Stock XYZ in 2007 for $10 each, your basis is $10,000. If you sold those shares today at $15 each, then your taxable gain would be $5,000 -- the $15,000 sale price minus $10,000 basis. You would owe $750 in long-term capital gain tax ($5,000 x 15 percent).
But if you received capital gains distributions, you paid taxes for the year you got them. These taxed gains are added to your basis. In this case, you start with your original $10,000 in shares, then add $1,000 in distributions you got in 2007 and another $2,000 paid out in 2008. When you sold the Stock XYZ in 2009 for $15,000 you subtract $13,000 -- the original cost of $10,000 plus your distributions over the years you owned the asset. Now, you have a taxable gain of $2,000 instead of $5,000 and only owe a $300 long-term capital gain tax bill.
Attitude, not portfolio, adjustmentsIf all this math is making your head spin, the easiest tax advice may be to adjust your mindset rather than your investment strategy.
"As investors look at portfolios, they probably don't have to look very far to see losses," says Steve Kunkel, director of taxes at CBIZ MHM in Los Angeles. "If people have mutual funds, a lot have a lot of gains this year. So even if the fund's value is going down, you might be paying out capital gains at the end of year.
"It is a bit of (adding) insult to injury, paying a lot of taxes for an investment that's gone down," says Kunkel. "But you have to ask yourself, are you willing to sell some of those holdings now to get a tax loss to offset some of these unexpected gains?"
Reputable financial and tax advisers will tell you that it's unrealistic to expect to pay no taxes. In fact, if someone offers you such an opportunity, it's likely an abusive tax shelter that's already, or soon will be, on the IRS watch list.
Rather, consider taxes as an inevitable part of most nest eggs. If you're making good investment decisions, your portfolio earning money and capital gains taxes -- particularly long-term ones -- are evidence of your financial security.
Or as one philosophical, veteran financial guru once said, aspire to pay a million dollar capital gains tax. A tax that large simply means your investments have earned much, much more.
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