Mutual Fund Investors Set To Enjoy Tax Free Period

by Mike Godfrey, Tax-News.com, Washington

09 July 2003

With rising equity prices restoring some much needed confidence to the stock markets, mutual fund investors may receive the added bonus this year of a tax break, as fund managers offset new gains against losses accumulated during the recent bear market.

"This is one of the good parts about the aftermath of a bear market" Don Cassidy, senior research analyst at Denver based fund-tracker Lipper Inc commented in a recent Los Angeles Times report. With a recovery now seemingly underway in earnest, the sector that suffered most in the downturn, technology, now looks set to gain the most from a period of tax free capital gains.

Many stock funds, including some large diversified funds such as Fidelity Aggressive Growth, Harbor Capital Appreciation and Vanguard US Growth, have accumulated sizeable tax-loss cushions, which is common after a long bear market, largely because such losses can be carried forward for up to eight years to be offset against future gains.

According to the Investment Company Institute, by the end of April this year, stock funds had realized losses on their books equal to 24% of total assets. However, this may not be the whole story, as more aggressive growth funds have racked up much more substantial losses over the last three years. For instance, the Janus Mercury fund's portfolio has $398 million worth of unrealized gains offset against a massive $6.8 billion in tax losses, according to the Los Angeles Times.

However, whilst this situation may make buying mutual fund stocks a more attractive proposition for existing investors, the current upturn is by no means guaranteed to become a fully fledged bull market, and stocks could well slump yet again. Also, as TCW's tax director Peter Brown points out to the LA Times, the tax benefit afforded by a fund with accumulated losses is a "tax deferral - not a permanent tax saving."

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