oddity in mutual fund gains/losses

Consider this oddity in the tax system that I noticed. Mutual funds hold shares of stocks. When those stocks pay dividends, the divs get distributed to the shareholders of the mutual fund. Also, when the fund sells shares of the stocks that it owns and realizes a long term capital gain, the LT gain also gets distributed to the fund's shareholders. This is all by law. As a shareholder, you pay income tax on the dividends/short term gains and capital gains tax on the LT gains. However, the share price of the fund goes down by the amount of the distributions per share. Let's say you sell your shares. When you file your tax return, you pay taxes on the distributions but get to take deductions for the loss on the sale of the shares.

Here's a quick example for clarity. Assume I had one share of a mutual fund and it paid $1/share in LT dists in 2007. I had to pay capital gains tax on that $1 in 2007, and the share price decreased by $1. Let's assume there were no market value changes and I sold the share in 2008 for $1 less than I bought it for. Since the value of the share went down due to the distribution, I am able to declare a $1 loss in 2008.

So I paid tax on $1 of LT gains in 2007 and get to deduct $1 in 2008. So far, everything is even. However, let's say I don't have any gains in 2008. This means I get to deduct the $1 loss from my ordinary income. Basically, I paid capital gains tax (15%) on the LT dist in 2007 but get to deduct the amount from my ordinary income in 2008, which would be taxed at around 28%.

Has anyone experienced this before?

Anyone? Even if you haven't experienced this, does the scenario make sense?

Havent had any experience of such Mutual Fund Oddity in my past. I also cant be sure enough if actually such a scenario makes sense or not.

Consider this oddity in the tax system that I noticed. Mutual funds hold shares of stocks. When those stocks pay dividends, the divs get distributed to the shareholders of the mutual fund. Also, when the fund sells shares of the stocks that it owns and realizes a long term capital gain, the LT gain also gets distributed to the fund's shareholders. This is all by law. As a shareholder, you pay income tax on the dividends/short term gains and capital gains tax on the LT gains. However, the share price of the fund goes down by the amount of the distributions per share. Let's say you sell your shares. When you file your tax return, you pay taxes on the distributions but get to take deductions for the loss on the sale of the shares.

Here's a quick example for clarity. Assume I had one share of a mutual fund and it paid $1/share in LT dists in 2007. I had to pay capital gains tax on that $1 in 2007, and the share price decreased by $1. Let's assume there were no market value changes and I sold the share in 2008 for $1 less than I bought it for. Since the value of the share went down due to the distribution, I am able to declare a $1 loss in 2008.
But the fund share would be up by $1 before the distribution. Fund prices are the value of the stocks they hold plus the cash the fund holds.


So I paid tax on $1 of LT gains in 2007 and get to deduct $1 in 2008.
Only if you had a loss. But if the shares the fund holds do not change, from where did the $l in LTCG (above) come?
So far, everything is even. However, let's say I don't have any gains in 2008. This means I get to deduct the $1 loss from my ordinary income. Basically, I paid capital gains tax (15%) on the LT dist in 2007 but get to deduct the amount from my ordinary income in 2008, which would be taxed at around 28%.

Has anyone experienced this before?[/QUOTE]

No, and I don't think they will.

Mutual Fund prices are determined by the value of the shares plus cash the fund holds. When a fund receives a dividend from a stock the NAV of the fund goes up. When the fund pays out that dividend the fund NAV goes down becasue the fund has less cash.

When a fund sells company shares for a LTCG, the fund price would not change because they counted that gain in yesterday's NAV as teh value of the company stock, and the cash will be counted in today's NAV. Now if the fund sold the stock because the company stock is decreasing, then the fund NAV may go up, because the fund is holding cash instead of shares of the company.

Good explanation, Clydewolf. Thanks. I understand now.

You still got paid that $1 as income, what happened later to the stock means nothing