Financial Q&A: Mutual-fund move creates taxing situation

Q:
In 2006, I transferred stock from one fund in a family of funds to another fund. Is this transfer the same as a sale? The IRS is treating it as ordinary income and billing accordingly. If the transfer is a sale and I do owe taxes, can I submit an amended return and pay taxes, penalty, and interest based on long-term capital gains? I had held the fund for nine years.

E.M., via e-mail

A: When you exchange a mutual fund, it's considered a sale even if it's in the same fund family. So Morris Armstrong, a certified financial planner in Danbury, Conn., thinks you have struck upon the right idea with your plan to file an amended return and report the basis correctly.

The gain may not be as much as you think once all the dividends and capital gains are taken into account. If they were re-invested, they will increase your cost basis.

Assuming you never paid any taxes on this sale, submit an amended return and pay the taxes. Jason Cole, a certified financial planner in Philadelphia, suggests that your accountant submit a letter to the IRS telling them that any failure on your part to properly pay taxes was merely an oversight. They might – might – let you off the hook on the penalty.

Q:
Life has been good to me and I would like to create investment savings for my two grandsons. Is land a good investment? Bonds?

S.B., via e-mail

A: Both bonds and land require an annual tax burden (income taxes on bonds, and property taxes on land). Because of that, Thomas Balcom, a certified financial planner in Lighthouse Point, Fla., advises that you consider buying small positions in two exchange-traded funds: domestically with the iShare S&P 500 Index (ticker: IVV) and, to gain some foreign exposure, the MSCI EAFE International (ticker: EFA). EAFE stands for Europe, Australasia and the Far East, so that's where you're money will be focused.

These positions don't generate a lot of taxable capital gains that accompany so many funds, and Mr. Balcom believes they would provide potentially higher returns than either land or bonds. And at your passing they'll be much easier to transfer, while also providing your grandchildren with a tax-blunting step-up in the cost basis.