J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

32.1 Timing of Your Investment Can Affect Your Taxes

You may buy a tax liability if you invest in a mutual fund that has already realized significant capital gains during the year. For example, if a fund is about to make a year-end capital gain distribution and you invest shortly before that, you will in effect have to pay tax on the return of your recently invested money.

You will be eligible to receive a forthcoming dividend or capital gain distribution if you are a shareholder of record on the “record date” set by the fund. On the “ex-dividend date,” the net asset value per share will be reduced by the distribution amount per share. If you buy before the record date, the higher cost for your shares will be offset by the distributions you receive, but you will have to pay tax on the distributions. On the other hand, because you paid the higher pre-distribution price, your higher basis will reduce any capital gain on a later sale, or increase any capital loss.

If you want to limit your current tax and forego the basis increase, postpone your investment until after the record date for distributions. By that time, the value per share that determines the price will have been reduced by the distribution. Before investing, you may be able to find out from the fund when distributions for the year are expected; call the fund or check the fund’s website for an estimate of projected distributions.