Can I transfer money between mutual funds without paying taxes?July 27, 2011: 5:05 AM ET
I have mutual funds that are not performing like they used to. I want to transfer the balances and automatic investments to another fund. These are not retirement funds, however. So how can I transfer them without incurring a tax liability? — Name and location withheld
Unfortunately, there is no way to "transfer" balances from one mutual fund to another without triggering a taxable event, says Garth Scrivner, a certified financial planner and CPA at StanCorp Investment Advisers in Albuquerque, N.M. You actually have to sell shares in your existing mutual fund and buy shares in the new one. If the shares that you sell have gained in value, you will owe taxes on that gain.
However, if the shares are worth less than the price you originally paid, you will have a capital loss. In that case, you will not owe taxes when you make the transfer. Plus, you will be able to use the loss to offset any capital gains you have for the year, and then up to $3,000 of ordinary income.
Also keep in mind that the IRS lets an individual taxpayer "carry forward" unused losses from prior years to offset current-year gains. So if the sale will cause you to realize a gain, look back to see if you have losses you can use to offset it.
All that said, your decision on whether to sell should based on a combination of factors — including performance, fees and asset allocation — not just the tax impact. Says Scrivner, "I always advise clients not to let the tax tail wag the investment dog."
— Walecia Konrad