Despite widespread stock market losses in 2008, several mutual fund companies have announced that they will make capital gain distributions to shareholders in mid-December.

This is a double whammy to investors because shareholders who hold mutual funds in taxable accounts must pay taxes on those capital gain distributions even if those capital gains were reinvested in the fund.  This may seem unfair when 1) you didn’t receive the money, and 2) your fund suffered a large loss for the year.

So why do mutual fund companies distribute capital gains to shareholders when the fund itself has incurred a loss for the year?  There are three reasons that funds are making payouts, even though they’re up to their ears in losses:

First, emerging markets and energy funds had big gains when the year began and realized some gains along the way. Then they suffered redemptions, which means that those gains have to be spread among fewer shareholders (i.e., the shareholders who did not bail have to pay the price for those who are trying to time the market).

Second, gains realized in November and December can’t be charged off against losses realized the next year.  Third, gains from currency contracts have to be distributed each year regardless of other losses in the portfolio. Thus, funds that hedged their foreign currency exposure are making payouts this year.

Companies that have stated they will have capital gain distributions include Fidelity (although according to Morningstar their gains look pretty small), Vanguard (the Vanguard Precious Metals and Mining fund tops the list with a capital gain distribution of 19.4% of the fund’s NAV), Oppenheimer, American Funds, and Tweedy Browne.

If you have a fund that is expected to distribute a large capital gain, and this fund is held in taxable accounts, you can sell before the distribution date to avoid sharing in the capital gain distribution.  You should check with your tax professional to see if this strategy makes sense for you.

To see if any of your funds will be distributing capital gains this December, go to the Web sites of your fund companies.