Hi Conrad
I don't know the exact details but:
1) Let's say a FUND (not the investor) has a cost basis of $50,000.
2) Let's say the FUND's investments are now worth $100,000
3) Let's say the fund owned ONLY Enron stock and got nervous (before it went down) and liquidated to cash before investing in something else.
The FUND now has a $50,000 gain that gets distributed to shareholders.
4)You buy $1000 worth of the fund just before they sell the stock (I think it could be after as long as they haven't distributed earnings yet )
4A) You buy the stock after they sell but before the dividend. They pay out a $500 dividend. You have to pay a tax on that even though you just got your own money back.
5) At year end your share of the gain is $500 and you will have to pay tax on that (long or short term depending on the FUNDs holding period not yours)
The FUND does not pay taxes as long as they pass thru earnings to the shareholders. It is what is known as a pass thru entity (Like REITS and Business development corporations as well as trusts)
That is why you do not want to buy funds that have a lot of UNREALIZED GAINS or are about to pay a dividend just after you are buying the FUND (at least in a taxable account)
I don't know if the above is the same situation or if I explained it exactly correctly but it is close.
People also get screwed with company stock options where they get an option for $10 and they exercise and HOLD the stock when it is $100. They have to pay tax on that $90 gain. If the stock then drops they still have to pay the tax even if the stock later goes down and they have a loss before they eventually sell. When they sell they can take the loss against other gains and or against $3,000 of ordinary income maximum each year. So if you have an initial gain of MILLIONS and no other investment gains you have nothing to take the eventual losses against (except $3,000 / year)
It is safer to sell the stock the day you exercise the stock option. Then keep half the gain liquid to pay taxes.
Toofuzzy
Take the road less traveled. It will make all the difference.
