Duck that distribution
Investor Daily: Watch out for losing funds bearing big tax bills.
NEW YORK (Fortune) -- This terrible, horrible, no good, very bad year for investors in international funds is about to get a little worse. Already saddled with 40% to 60% losses, some investors who own international or emerging markets funds in taxable accounts are about to be hit with a hefty tax bill. IRA and 401K investors are safe.
How could this happen? From 2003 through 2007, foreign funds were among the mutual fund industry's biggest winners. Morningstar's emerging markets category, for instance, recorded a 22% average annual return.
Problem is, fund investors ran for the exits when foreign markets began to plunge in early 2008, and that forced fund managers to sell a lot of highly-appreciated foreign stocks. The capital gains on those stock sales are now being passed along to the fund-holders left behind - even those who weren't around for the big gains of 2003 to 2007.
Take the ING Russia fund (LETRX). The fund is down 64% year to date. Yet with redemptions forcing ING to liquidate many long-term positions, ING has announced that the fund will likely distribute more than $8 a share in long-term capital gains this year - a huge sum for a fund with an NAV of $18. With these long-term capital gains taxed at a 15% rate, an investor now with $10,000 in the fund will get saddled with a $690 tax bill - and that's on top of a $20,000 investment loss (assuming he's owned the fund all year). Talk about rubbing salt in a wound. (Many domestic funds made large distributions last year, so they may not be dinging shareholders as badly this year.)
The good news: You've still got time to avoid the tax hit. Most funds don't distribute gains until December. So if your fund is facing a big tax liability - fund companies will usually provide estimates if you call their 1-800 numbers - our advice would be to sell now.
Plus, if selling creates a capital loss - very likely for anyone who's owned their international fund for three years or less - the loss can be carried forward to offset future capital gains. Investors can also deduct up to $3,000 in capital losses from ordinary income.
Boston financial planner Janet Tighe is selling many of her international and emerging markets fund holdings. Tighe, of Mintz Levin Financial Advisors, is temporarily shifting this money into exchange-traded funds with similar international exposure, with the intention of repurchasing her actively managed funds after the distributions are made.
Another strategy would be to shift into new foreign funds that don't have any long-term gains to distribute. Two examples: IVA Worldwide and IVA International funds, which are run by the former portfolio managers of the well-regarded First Eagle Global fund. The IVA funds were launched Oct. 1, and they've already raised $170 million - an amazing sum in this environment. Co-manager Charles de Vaulx says that a lot of the money is in fact coming from financial advisors who are selling competitor funds before any capital gains are distributed. Says de Vaulx, "It's definitely a factor." 
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