For tax-loss purposes, are you able to transfer money from one fund to another in the same fund family, and then back again?
QUESTION: To take advantage of tax losses, are you able to transfer money out of one fund in a fund family for 30 days and into another fund in the same family, and then buy it back?
ANSWER: Family ties don't mean a thing when it comes to tax-loss selling of mutual funds. "For legal and tax purposes, there is no investment relationship between different funds just because they have the same brand name," says Don Cassidy, senior research analyst at fund-tracking firm Lipper and author of the book, "It's When You Sell That Counts." As a result, you could sell the Fidelity Select Technology fund (FSPTX), move that cash into the Fidelity Select Biotechnology fund (FBIOX) for 30 days, then return to your original choice.
Why would you want to do that? As you know, selling some of your losing investments can be a strategic tax move if you're also facing capital gains this year. (Lucky you!) That's because capital losses can be used to offset those gains. Any losses in excess of your gains can be applied to $3,000 in ordinary income and then carried forward for future tax returns. First, however, you need to determine that you actually have a loss. (Remember, your fund may be in negative territory this year, but depending on when you bought your shares, you may still be sitting on a gain.) In order to do so, you'll need to calculate the tax basis of your fund shares.
Assuming you do have a loss but still want the investment as part of your portfolio, you can sell the fund and stay out of it for 30 days, and then buy it back. During that period, you can park that money almost anywhere — the same fund family, another fund group, a bank account. What you can't do is repurchase the same fund — or one that's "substantially identical" — within that period. While there's nothing illegal about changing your mind, it does activate the notorious wash-sale rule, which disallows the loss. Triggering the wash-sale rule doesn't mean that you can never take the loss — but you're going to have to wait until you sell the shares again and honor the 30-day period, explains Cassidy. (We know this is very tricky stuff: Click here for a more detailed explanation.)
So what are substantially identical funds? They aren't two portfolios with the same general investment goals, such as AIM Global Health Care fund (GGHCX) and Hartford Global Health fund (HGHAX). Instead, the Internal Revenue Service means investments that could be construed as identical securities, such as two S&P 500 index funds, like the Vanguard 500 fund (VFINX) and the California Investment S&P 500 Index fund (SPFIX). In this case, it would even apply to the exchange-traded funds, or ETFs, known as Spiders, or Standard & Poor's Depositary Receipts, which also track the large-cap index, notes Cassidy. But you probably don't have to worry about this too much, since you're unlikely to find substantially identical funds offered by the same fund company.
At this point, let's say that you're planning to sell one fund within a fund family, buy another and switch back again. Before you do anything, first check that the fund you've selected as a temporary parking spot has either already made a capital-gains distribution this year, or isn't expected to make one during the 30-day period. Ignore this rule and you could be walking into another tax minefield called "buying the distribution." Capital-gains-distribution estimates are usually posted on a company's Web site; if not, call the fund company. Second, remember that many funds slap short-term investors with redemption fees of 1% or 2%, which could end up negating those tax savings. Redemption-fee information is located in a fund's prospectus within the fee table.
Finally, even if your parking-place fund is free of distribution concerns and redemption fees, be sure to consider whether harvesting your tax loss would impede your longer-term investment goals or create other tax complications. After all, if your original fund increases markedly during those 30 days, you'll be buying those shares back at a higher price, notes Peter Di Teresa, senior analyst at fund tracker Morningstar. "And if you park the money in a different fund that also makes significant gains," adds Di Teresa, "you'll incur a short-term gain by selling it."