If you’re considering investing in a stock fund for a possible rebound, ask the fund’s phone rep if it has a tax-loss carryforward. If so, that fund can generate future gains without passing though taxes to its shareholders.
Suppose Fund XYZ had a $200 million loss from its trades in 2008. If XYZ had realized a $200 million gain, it would have had to pass through that $200 million gain to the fund’s investors shareholders, who would have owed tax on their share of the gain.
A mutual fund, however, can’t pass through losses to shareholders. Instead, Fund XYZ’s $200 million loss is carried forward. If stocks rebound this year and Fund XYZ has a $40 million trading gain in 2009, it can use its $200 million loss carry-forward to completely offset that gain. Its shareholders would not get a taxable capital gains distribution in 2009.
Moreover, Fund XYZ would still have a $160 million loss to carry forward into 2010. Therefore, investing in a mutual fund with a tax-loss carryforward from 2008 may provide you with years of tax-free gains in a future bull market.
