Buying and selling securities is hard enough, but investors shopping for a good mutual fund have something else to worry about: Ex-dividend dates. Not understanding how these work can bring a surprise at tax time.
A mutual fund is required to distribute annual income to shareholders. These distributions are often taxable in the form of interest, dividends and capital gains. Each year, fund trustees pick a date on which all shareholders will be eligible for the annual distribution. This is the ex-dividend date.
Owning shares on the ex-dividend date is not always a good thing. Some investors buy a fund just before the ex-dividend date, causing them to receive a taxable distribution right off the bat. The problem is that the price of the mutual fund drops by the amount of distribution. Since the price of the fund shares before and after a distribution reflect the amount of the dividend, the investor is paying income tax on part of his purchase price. This doesn’t mean that buying immediately before the ex-dividend date is always bad; it just means that investors should be aware of this date.
Just as buying a fund before the ex-dividend date might be something to avoid, selling a fund before this date could be a tax-smart move.
Selling appreciated shares that you have owned for a year or more could produce income taxed at the favorable long-term capital gains rate – as opposed to receiving distributions taxed at ordinary tax rates.
Keep in mind that if you own a mutual fund in a qualified retirement account, the annual distribution will not be subject to immediate taxation, making the tax aspect of your purchase timing a moot point.
Mutual fund investing can be advantageous if you know the rules. For guidance, contact a certified public accountant.
Barry Gilchrist is a certified public accountant with Wessel & Co. of Johnstown.