How to Manage Your Fund Investments Tax-Efficiently

When it comes to managing your mutual fund investments tax-efficiently, the good news is that you have until Dec. 31 to execute a trade and have it reportable for the 2003 tax year. The bad news is that selling shares in a mutual fund is often trickier than it seems.

Yet, with a little organization and a lot of patience, you can still optimize your 2003 tax scenario in your investment portfolio.

You've probably already scoured your portfolio for gains and losses to match -- if not, that's your first step. Every dollar of a capital loss means you won't owe tax on a dollar of gain. So whether you want to take profit on that General Electric you've been holding for two decades or simply dump that Sprint PCS that was so good to you this month, you can cherry-pick a few losses from your portfolio -- mutual funds included -- to offset the tax on those gains. (For more on the matching rules, click here.)

Determining exactly what your gains and losses are, though, is a lot easier with individual securities than it is with mutual funds. With mutual funds, even if you move money from one fund into another in what seems like a single, seamless transaction, a taxable event still has occurred. You'll owe tax (or can claim a loss) on the sale, and the amount you transfer to another fund will serve as the initial cost basis for that fund. But that's only the beginning.

Figuring out the cost basis of your shares can be a tricky business. But no matter how frustrating the process seems, it's a crucial step.

Defining the Cost Basis

The cost basis is the amount of money you've invested in your shares -- any amount above the cost basis is your gain. Basis is essentially the money you plunked down to buy the initial shares, but it also includes sales charges and redemption fees you paid for the share upon purchase or sale. (If you're selling shares and moving the proceeds into a different fund in the same family with a reduced load charge, you must have held the shares for more than 90 days to include the load charges in the basis.)