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Tax Question. Hedge Funds, mutual funds.


Laxputs
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My accountant is telling me I have to pay taxes on the capital appreciation of some of my hedge funds and mutual funds where I have not sold any shares. The fund has appreciated from what it was valued at last year. I have not sold shares. Do I have to pay taxes on the gains?  This seems nonsensical to me as a person would then have to sell some of their shares to pay the taxes if they had no other income. Is it correct that I owe taxes there?

 

TIA

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I'm a little confused here though--are you invested in hedge fund(s) and they didn't explain that it was a pass-through entity?  It makes sense for some of the other entities (e.g., mutual funds), since it is easy to buy them without knowing how taxes work, but a hedge fund is typically a fairly involved investment process, so I would have expected that to have come up.

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One thing that puzzled me. Please help me clarify.

If a fund realized some gains and I invest in the fund at the end of the year, I still have to pay my share of the realized gain of other people, even though I gained nothing. Is this right?

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"One thing that puzzled me. Please help me clarify.

If a fund realized some gains and I invest in the fund at the end of the year, I still have to pay my share of the realized gain of other people, even though I gained nothing. Is this right?"

 

For a US mutual fund (they pay their gains as a distribution near the year end), yes, this is true.

 

To compensate, the fund NAV is reduced by the distribution amount, so it's really just a timing issue (you could sell immediately and offset the 'gains' with losses on the sale).  However, in certain cases, the timing issue and size of the distribution can be quite troubling.

 

However, it is truly just a timing issue.  It happens in your personal account too (you can have a year where  your returns are negative, but your tax liability is big), it's just a timing issue in all but esoteric cases.

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"One thing that puzzled me. Please help me clarify.

If a fund realized some gains and I invest in the fund at the end of the year, I still have to pay my share of the realized gain of other people, even though I gained nothing. Is this right?"

 

For a US mutual fund (they pay their gains as a distribution near the year end), yes, this is true.

 

To compensate, the fund NAV is reduced by the distribution amount, so it's really just a timing issue (you could sell immediately and offset the 'gains' with losses on the sale).  However, in certain cases, the timing issue and size of the distribution can be quite troubling.

 

However, it is truly just a timing issue.  It happens in your personal account too (you can have a year where  your returns are negative, but your tax liability is big), it's just a timing issue in all but esoteric cases.

 

Does this mean the fund has to estimate each investor's tax bracket and distribute cash for him to cover tax?

If I bought a fund at the year end, I got "gains" that may push up my tax bracket by one notch, even though I haven't actually gained anything from this fund.

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Does this mean the fund has to estimate each investor's tax bracket and distribute cash for him to cover tax?

 

- Nope, you get a "gains" distribution which is cash, but it's 100% taxable (at whatever long term, or short term, etc).  You own your tax, not the mutual fund.

 

If I bought a fund at the year end, I got "gains" that may push up my tax bracket by one notch, even though I haven't actually gained anything from this fund.

 

- Yep

 

* I'm not sure about non-mutual funds, my commentary is only about mutual funds.

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If what Benhacker is saying is true in the US, Canada is different. Here, if you buy a fund at the end of the year, income and/or gains earned prior to your investment are not "distributed" to you. You would only receive a distribution if you had invested and then income and gains had accrued on your investment. Otherwise, why would anyone invest after Jan. 1?

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