Even tax-efficient funds can incur large capital gains when they sell to finance shareholder redemptions. That means you might owe gains tax even as the fund value declines. Go to www.morningstar.com to find out how much of a fund’s value is pre-existing appreciation on investments. When comparing two similar funds and one’s value is based more on appreciation, the other fund may be the better investment.
The parents reduced their taxable income by $1,000 by checking a fund’s capital gains exposure. Since the parents income was taxed at the 20% tax bracket, the income reduction may decrease their income taxes by $200 ($1,000 x 20%).
If you are in a combined (federal, self-employment, and state) tax bracket of 20%, you could reduce your taxes up to $200 for every $1,000 of income reduction by checking a fund’s capital gains exposure.