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Can't Win for Losing

A mutual fund tax quirk limits your capital losses.

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This story appears in the July 2003 issue of Entrepreneur. Subscribe »

When the stock market was going gangbusters and virtually every fund was posting impressive returns, the tax man nicked investors each year for capital gains (assuming the funds weren't held inside tax-deferred retirement accounts). You might never have sold a share or seen a penny of profit, but the funds "passed through" their capital gains to you at tax time. The fund managers bought and sold stocks during the year, even if you didn't. Whatever capital gains the stocks generated were divvied up among the shareholders at year's end, and you paid the freight.

Now that virtually every fund is losing money, they should pass through their capital losses so you can write them off on your taxes, right? Think again. This is the IRS we're talking about, so of course it isn't that simple. Thanks to a quirk in the tax code, investment losses stay within the funds even if investment gains don't. As a shareholder, you get nada for internally generated capital losses when it comes to tax time.

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