Do I owe capital gains tax if I sell this mutual fund?
Q. Say I have a mutual fund XYZ that I want to keep with the same broker but change it to an exchange-traded fund (ETF), would I have to pay capital gains as if I was selling it?
— Investor
A. If you’re talking about a mutual fund held in a non-qualified account, rather than an IRA or other retirement account, you’re probably looking at a tax bill.
In general, if you sell a mutual fund position with unrealized gains, it will result in realizing the gains and you will incur capital gains taxes.
If your holding period of the mutual fund is more than one year, you will incur the long-term capital gains tax rate, said Deva Panambur, a fee-only planner with Sarsi, LLC in West New York and an adjunct professor of personal finance at Montclair State University.
He said mutual funds are required by law to regularly distribute capital gains on the sale of their underlying investments. These distributions are taxed in the year it is made, and as such, mutual fund positions usually do not have a significant amount of unrealized capital gains, he said.
“On the other hand, if you have unrealized losses, you can offset it against capital gains elsewhere in your portfolio and after that any remaining loss can be used to reduce taxable income up to $3,000 per year — or $1,500 if married filing separately,” he said. “This is assuming that the ETF you are purchasing is not substantially identical to the mutual fund you are selling. If not, you will run up against wash sale rules.”
Now, specifically to your question: Panambur said some investment firms have mutual funds that offer ETF shares and allow you to convert from the fund to the ETF shares of the same fund in a tax-free manner.
“This conversion could be tax-free if the broker that holds your mutual fund also allows the conversion,” he said. “Some brokers may charge a fee for the conversion.”
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