A few years ago I bought a mutual fund in late November, and unbeknownst to me, the fund was set to do an annual dividend distribution about 3 weeks later in mid-December.
I bought 5000 shares at $10 per share (for $50000 total), and the dividend was about 10%. When I got the dividend notice in the mail, it indicated that the new share price was $9 per share, and I now own 5555 shares (but my total account balance was unchanged, and still stayed at $50000).
However, (and this is the question), they also declared in my end-of-year tax notice that this dividend gave me a taxable capital gains distribution of $5500, which I owed income tax on. How is that possible?? My account balance never changed, and had I made no actual money yet, but somehow I owed taxes? (note that this year was an overall losing year for the fund, with a negative return)
The next year, I received a similar annual dividend in December, but this time my account balance increased by the 10% of the dividend, so having taxable capital gains was appropriate. (also note that this was a positive year for the fund)
I just called the fund twice to ask this, and the phone reps seemed unable to grasp my question, and only could say "well, you received a dividend and dividends are taxable." But I gained absolutely nothing from my dividend, so how is it taxable?
Did I get screwed the first year because I bought into the fund too late in the year? I'm looking at buying again now since the price is good, but I don't want to get hit with another phantom taxable distribution.
Is anyone familiar with what causes this kind of situation of receiving a "taxable dividend" that doesn't actually increase the account balance? Is it because I bought too late in the year? Or is it because the fund had a negative return that year? Do I wait until after the distribution date this year to buy?