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https://www.businessinsider.com/uit-unit-investment-trust says:

UITs come with much lower expense ratios and also come with favorable tax terms. Because of the way capital gains taxes are structured, it's possible to lose money on a mutual fund and pay taxes on gains you never actually appreciated. For example, if the shares were sold right before you got your hands on them, you could find yourself with a shared tax liability for someone else's capital gains.

I'm slightly confused as to what this means---could someone provide an example with concrete numbers?

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Yes, it is possible to pay capital gains tax while holding a mutual fund that has gone down in value.

Mutual funds have something called “capital gain distributions.” Inside a mutual fund, when a manager sells an asset for a gain, that gain (cash) has to be distributed among all the holders of the fund. This is paid out to everybody either in cash or by issuing additional fund shares, similar to how dividends are paid when you hold individual stocks.

When you receive these capital gain distributions, you need to pay capital gains tax on them.

I personally have been in this situation: The value of my mutual fund investment had gone down (due to a down stock market). However, because I had been given additional shares over the year from capital gains distributions, I had to pay some capital gains tax even though my investment had gone down in value and I hadn’t sold anything.

However, it is not accurate to say, as the article does, that in this situation you are paying tax on someone else’s gains. You only pay tax on capital gains distributions when you are actually given the distributions (proceeds from the assets sold at a gain), either in the form of cash or additional fund shares.

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    If the distribution is made shortly after you purchase the mutual fund shares, you are paying taxes on other shareholders' gains. The fund's NAV goes down proportionally to the distribution, so this paper loss cancels out the cash you received, yet you still have to pay tax.
    – Barmar
    Aug 7 '21 at 17:34
  • And if the fund held the security for a long time before selling it, there may be quite substantial gains that are realized, from the growth that occurred before you bought shares.
    – Barmar
    Aug 7 '21 at 17:35
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    Your statement that you are paying taxes on other shareholders' gains and the phrasing in the article may be interpreted that you are subsidizing other shareholders. That's not true since they will have to pay taxes on their gains at their tax rate. If you receive the distribution, you will pay taxes on the fund's realized gains since the last distribution which must be passed to shareholders of record on the current ex-div date. Aug 7 '21 at 18:37

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