A Mutual Fund Exchange Is a Taxable Event

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A Mutual Fund Exchange Is a Taxable Event

Here is a common situation that causes investors to be taxed, often without their realization. One of the conveniences of mutual funds is the ability to exchange one fund for another (usually within the same family of funds). Such exchanges usually do not incur any additional fund fees or commissions. However, beware the tax pitfall.

Things To Know

  • When you shift money from one fund to another, the IRS views it as a sale of your shares followed by a new purchase.
  • The exception is when transfers are made within a qualified retirement plan.

The tax pitfall

When you shift money from one fund to another, even between funds in the same family, the Internal Revenue Service views it as a sale of your shares followed by a new purchase. You will be taxed on any capital gains made from the transfer.

The exception

The exception to this is when transfers are made within a qualified retirement plan, such as an individual retirement account. Even though an exchange is taxable, when made within a retirement plan, there are no immediate tax consequences until plan funds are distributed.

Why you should keep careful records

Be sure to keep careful records of mutual fund transactions including dates and amounts paid to purchase shares directly, dividend and capital gains reinvested, and amounts received when redeemed or exchanged. These affect your cost basis used to determine capital gains and losses.

Keeping careful records of mutual fund transactions can help you avoid an unpleasant experience with the taxman over mutual fund investments.