For those of you who invest in mutual funds outside of your retirement portfolio, you obviously felt the pain that everyone else felt when you opened your statement each month last year. However, you may have thought that you would have losses to report on your 2008 income tax return as a result.
Valerie RumboughNet realized losses (up to $3,000 after being offset with gains) may be a small blessing in disguise, since it may reduce your taxable income and give you a small tax break. Imagine your shock and dismay when the investment company sent you a 1099 reporting gains instead!
How can this be, when you watched your portfolio dry up? Mutual funds are made of up of hundreds of different stocks and bonds bundled together. When the fund managers review the various companies they have invested in, they may see one that has performed well, but may not have a chance of doing so in the future. They realize that this is a good time to sell. They operate on a philosophy of buying stocks and bonds when they are cheap, and selling them when they are expensive. This is how they make money for you. However, the gains they realize when doing this have to be passed on to you as a shareholder of that fund.
There is still a little ray of sunshine in this, however. The income you have to recognize will increase your basis, or investment, in the fund. Then, when you get ready to sell some or all of your fund shares, any gain you may have otherwise had to recognize will be reduced somewhat. Conversely, when fund managers see an investment that seems to be going south with little or no hope for return, they may sell it, even if at a loss, to “stop the bleeding” in the fund. When this is passed on to you, you reduce your basis, or investment, in this fund when you recognize it on your income tax return.
The lesson to learn in this is to not only keep track of what you have paid for fund shares, but also keep track of gains and losses you have recognized on your tax return as a result of that investment. This information is essential to have when you sell any of your shares.
And as you watch your portfolio go up and down, remember that even if we don’t know what the future holds, we know who holds the future. Let’s trust in Him who really is in control.
Editor’s note: Valerie Rumbough, CPA, CFP is Chief Operations Officer with the Baptist Foundation of South Carolina. If you would like more information concerning the above article or other matters, feel free to contact her at (800) 723-7242. In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purposes. Please consult your own tax advisor.