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Why Am I Paying Capital Gains Tax When My NAV Is Down?

It may seem unfair to have to pay taxes on an investment that has dropped in value, but it’s important to remember that if you’re paying capital gains tax, it’s because you’re making money — even if the fund’s net asset value is currently down.

Raj Vijh: : The purpose of these funds is to make money, right? So when you make money then, unfortunately, the downside of that is you get taxed. Paying taxes is not necessarily a bad thing. It means that you made money, but there are certain things that could happen that could make you feel, “Why am I paying taxes in this situation? My fund actually went down but I’m paying tax, why is that?” So there’s an important concept here with taxes, which is taxes are payable on earnings that the securities have. A security like a fixed income security may generate interest income, so you’re going to get that interest income because that company is paying interest on the shares and you get interest income, no matter what.

Now the fund has certain expenses so you can reduce your income by offsetting that with expenses, but at the end of the day, the fund has to distribute out all of the income that it earned in that year to the unit holders. It’s essentially a flow-through vehicle. That’s kind of one piece of it. The other thing that’s happening in the fund is the shares are being bought and sold by the fund manager and he or she may buy them and then sell them later for a profit or loss. If you do it for profit, then you’ve got a capital gain, and for loss, you have a capital loss. So you’re going to get income from a fund, and if the shares are being sold, you could get a gain or a loss. These two things happen sort of independently, so a fund may have income but that year, if the market value falls, your NAV will go down. But you’ve still got that income, so you’ve still got to pay taxes.