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Why did my mutual fund hand me a capital gains bill even though I didn't sell?

Answer

Mutual funds are required to distribute the net capital gains they realize inside the fund each year to shareholders, who then owe tax on them in a taxable account. When the fund manager sells appreciated holdings, for rebalancing, to meet redemptions, or because a stock was bought out, those gains flow to you as a year-end capital gains distribution, reported on Form 1099-DIV, regardless of whether you sold a single share. Painfully, this can happen even in a year the fund's price fell. This is why tax-efficient, low-turnover index funds and ETFs are preferred in taxable accounts, and why buying a fund late in the year right before its distribution date can stick you with tax on gains you didn't benefit from.

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