Buying the Dividend or Capital Gain Distribution and Wash Sales
One of the advantages of investing in a mutual fund is the ability to purchase and redeem shares on any day the market is open. Potential shareowners indicate the amount they wish to invest, and the share price is determined after the next closing of the financial markets.
Buying the Dividend or Capital Gain Distribution
There are times when it may not be in your best interest to purchase shares because the fund is about to make a dividend or capital gain distribution. These shares may generate income, which may lead to a tax liability for you. When this occurs, it's called buying the dividend or capital gain distribution.
Consider this hypothetical scenario of two investors who are interested in shares of a stock fund investing primarily in large companies:
Dividend or Capital Gain Distribution Example
|Investor A||Investor B|
|Invests $10,000 in the fund on June 24. Because the net asset value of the shares is $50, Investor A is able to purchase 200 shares.||Waited until the day after the distribution is made. Investor B's $10,000 purchased 206.186 shares (10,000/48.50) but she has not received any dividend income, so there are no taxes assessed.|
|On June 25, the fund makes a previously announced distribution of $1.50 per share, reducing the net asset value to $48.50 per share. Investor A receives $300 in dividend income or capital gain that is reinvested in the fund.|
|Investor A's original shares are now worth $9,700 ($48.50 x 200) and the reinvested dividend purchases 6.186 additional shares ($300/48.50). Investor A now has 206.186 shares and a taxable income of $300.|
The dividend example is hypothetical and is not intended to represent any specific type of investment. The example doesn't include the impact of any expenses or taxes that would be associated with an actual investment. If such costs had been taken into account, the results shown would have been lower. It shows what can happen when a purchase is made immediately prior to a dividend or capital gain distribution. You should consult a tax adviser for additional information.
Another transaction that may carry tax consequences is a wash sale. This occurs when shares of a mutual fund or individual securities are sold at a loss and substantially identical replacement shares are purchased within 30 calendar days either before or after the sale. Rules set by the Internal Revenue Service prohibit shareowners from declaring a capital loss when a wash sale occurs.
The initial sale may have been made in order to declare a short- or long-term capital loss for tax purposes. A capital loss can ordinarily be used to offset a capital gain on your personal income taxes, lowering the amount you may owe for the year. However, purchasing substantially identical shares within either 30 calendar days before or after the sale will prevent you from declaring a loss on your tax return.
The disallowed loss is added to the cost basis of the replacement shares. In other words, if you had originally paid $20 for the individual shares, sold them for $10 (a loss of $10 per share), and purchased replacement shares for $11, your cost basis for the new shares is now $21 (the $11 purchase price plus the $10 loss). In this way, depending on your tax situation, the capital loss on the initial sale may eventually be realized when the replacement shares are sold.
Your holding period for the replacement shares is also changed to include the amount of time you held the original shares. While that may not seem like such a problem, it can make a difference in determining a short- or long-term capital loss or gain when you decide to sell the shares.
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Before investing, consider the funds' investment objectives, risks, charges and expenses. Contact State Farm VP Management Corp (800-447-4930) for a prospectus or summary prospectus containing this and other information. Read it carefully.
Investing involves risk, including potential for loss.
A 10% tax penalty may apply for withdrawals from tax-qualified products before age 59½.
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