igghy wrote:^Thank you. That's what I was wondering. I don't quite understand. If the fund's cost basis is $100M, unrealized capital gains $100M when I buy a share for $100, how does that play out?
An unrealized gain is the difference between what was paid for an asset and what the asset is now worth. When the asset is sold, that is a realization of the gain, and tax is owed. Thus an unrealized gain represents a potential
In your example, the fund's net assets would be $200M, with a cost basis of $100M and another $100M in unrealized gains. Suppose that 2% of the fund is in the XYZ Corporation, which is now trading at $20; your own $100 investment thus includes $2 worth of XYZ, or 1/10 of a share. If the fund bought XYZ for $10, then it has an unrealized gain of $10 per share of XYZ. If it sells the XYZ stock, it has a capital gain of $10 per share, and tax is owed on that $10. The fund does not pay taxes itself; instead, it will make a capital-gains distribution at the end of the year; with your one share of the fund, you own $1 of the capital gain and will pay tax on that $1.
But you only pay tax if the gain is realized by a sale. If you hold a stock and never sell it, you don't pay any tax. If you give the stock to charity, the IRS does not consider it to be sold, and you don't pay any tax.
Similarly, if a fund never sells the stock (which is a common situation for index funds), you don't pay any tax. If the fund gives the stock away (which is what happens in an ETF redemption), the unrealized gain disappears. Thus most stock ETFs rarely distribute capital gains.
You will still owe taxes on your own gains in an ETF, and this is the reason for livesoft's quote. If he bought VBR at $40, then he will have a big tax bill when he sells, because the fund is now worth $71.37. Thus he doesn't want to sell the fund to switch to another fund, as he will have less money to reinvest after paying taxes. Presumably, he plans to sell the fund when he needs the money (likely in retirement).