Cleaning up a fund portfolio: the purging elections that end PFIC pain

Figures relate to tax year 2025 (US)

You hold three funds inside a stocks and shares ISA. Your British adviser calls them tax free. Your American return calls each of them a PFIC, and the default rules make them more expensive the longer you hold them.

There are ways out. Some involve an election, some involve selling, and the right answer depends on the size of the holding and how long you have held it. So this guide covers the purging elections, the alternatives, and the deadlines that decide what is still available.

Key takeaways

• Most British funds are PFICs for an American, including those inside an ISA.
• The default rules spread gains across your holding period and add an interest charge.
• Electing mark-to-market taxes annual growth as ordinary income instead.
• A purging election stops the old taint, at the cost of tax now.
• Selling a small holding is often cheaper and simpler than any election.
• Elections belong on a timely filed return, so the calendar matters.

What is a PFIC?

It is a foreign company that earns mostly passive income or holds mostly passive assets. Nearly every pooled fund outside America fits, including unit trusts, open-ended investment companies, investment trusts and exchange traded funds. The wrapper around them makes no difference to this test.

An ISA is a British tax wrapper, not an American one. The funds inside it keep their character for US purposes, so the PFIC rules apply exactly as they would in an ordinary account.

Why the default rules hurt

Under the default PFIC regime, an excess distribution or a gain on sale gets spread back across every year you held the fund. Each slice attracts the highest rate in force for that year, and an interest charge runs on top.

So the same £10,000 gain costs more for someone who held the fund for fifteen years than for someone who held it for two. Time is the multiplier, which is why holding on rarely helps.

The interest charge is the part that surprises people. It is not a penalty for doing something wrong. It simply reflects how the PFIC regime works.

The three ways to be taxed on a PFIC

Three PFIC regimes exist, and only one applies by default. The other two need an election, and each has conditions. The table below sets out the differences before we look at cleaning up an old holding.

Why the qualified electing fund election rarely helps here

Because it depends on the fund, not on you. A qualified electing fund election needs an annual information statement prepared to American rules. Most British fund managers do not produce one, and they are under no obligation to start.

Some larger managers now provide statements for certain share classes. It is worth asking, because the election gives the cleanest long-term treatment where it is available.

What is a purging election?

It is an election that cuts off the old PFIC treatment so a fund can move onto a cleaner basis. You treat the holding as sold at market value, pay the tax that would arise under the default rules, and start again with a fresh holding period.

The cost is tax now instead of tax later. The benefit is that the interest charge stops growing, and future growth falls under a simpler regime.

In our practice, purging makes most sense for a holding you intend to keep for years. For anything you would sell soon anyway, selling is simpler.

How does a deemed sale election work?

You elect on Form 8621 to treat the holding as sold on the first day of the year in which the fund stops being a PFIC for you, or when you move to mark to market. The default rules then apply to that gain, including the interest charge. From that point the old PFIC history disappears.

There is no actual sale, so nothing leaves your account. That matters for anyone who wants to keep a particular fund but stop the compounding problem.

Cash flow matters here. The tax arrives without any sale proceeds to pay it, so the election needs planning alongside the rest of your year.

Mark to market as a route out

The mark to market election taxes each year's growth as ordinary income, with losses allowed only to the extent of earlier gains you reported. For a PFIC with a published daily price, it is usually available.

In the first year of the election, the default rules still apply to the built-up gain. That first-year charge is effectively the purge, after which the annual treatment is straightforward.

The ordinary income rate is the trade-off. Growth that might have attracted capital gains rates now meets your marginal rate instead, every year, whether or not you sell.

What should you buy instead?

Direct shares, US-domiciled funds, or cash. None of those is a PFIC, so the reporting disappears with them. Many Americans in Britain hold individual British shares inside an ISA for exactly this reason, because the wrapper still shelters them from UK tax.

US-domiciled funds raise a different problem. Some British platforms will not sell them to retail investors, and holding them can affect your British reporting. So check what your platform allows before planning a switch.

Cash inside an ISA is simple but rarely a long-term answer. It avoids the PFIC rules while giving up the growth you invested for.

A worked example

The figures below are illustrative. Take an example: an American in Bristol holds a British equity fund bought in 2016 for £20,000, now worth £34,000, inside a stocks and shares ISA.

Selling today produces a £14,000 gain spread back over ten years, at the highest rates for each year, with interest added. The dollar cost is meaningful but final.

Electing mark to market instead produces the same first-year charge on the built-up gain, then taxes future growth annually. If the fund is a long-term holding, the election ends the compounding problem for good.

For a holding of this size, many clients simply sell and reinvest in a US-domiciled fund or direct shares. The decision usually turns on the ISA allowance and on what they want to own next.

Does selling inside the ISA solve it?

It ends the PFIC problem, but it still counts as a taxable disposal in America. Britain sees no gain because the ISA shelters it. The IRS sees a sale, applies the default rules, and expects the tax. Nothing about the wrapper changes that.

The proceeds can stay inside the ISA, which preserves your British allowance. What you buy next decides whether the problem returns. Our guide to the ISA and PFIC problem covers the alternatives that keep the wrapper useful.

What about cash ISAs and Lifetime ISAs?

A cash ISA holds deposits, so no PFIC is involved at all. The interest is simply taxable in America and exempt in Britain. A Lifetime ISA depends on what sits inside it, because the cash version behaves like a deposit and the stocks version usually holds funds.

The government bonus raises its own questions. Our guide to the Lifetime ISA and US tax sets out how America handles the bonus and the growth.

How much does a PFIC cost to report?

More in fees than in tax, for small holdings. Each fund needs its own Form 8621 every year, and each form takes time to prepare. Four funds mean four forms, repeated annually for as long as you hold them.

That running cost often decides the question. A £3,000 legacy fund can cost more to report each year than it earns, which makes selling the obvious answer.

Larger holdings justify the work. There the choice between electing and selling turns on tax, not on preparation fees.

How to clean up a portfolio

Work through it holding by holding, because the right answer differs for each. A small legacy fund and a large core holding rarely deserve the same treatment.

1. List every fund you hold, inside and outside any wrapper, with purchase dates and costs.
2. Confirm which holdings are PFICs, which covers nearly all pooled funds outside America.
3. Ask each manager whether it produces a qualified electing fund statement.
4. Estimate the default charge on each holding if sold today, including interest.
5. Decide for each one: sell, elect mark to market, or purge and continue.
6. File Form 8621 for every holding each year, whether or not you sold anything.
7. Choose replacements that avoid the problem, then review the portfolio annually.

What if you never filed Form 8621?

You are in the majority, and the position is fixable. A missing form leaves the statute of limitations open on the return it belonged to, which is reason enough to deal with it. For non-willful taxpayers, the streamlined procedures accept late forms alongside amended returns.

You still calculate the tax, including any interest charge on disposals. What the program removes is the penalty layer. According to IRS guidance on the procedures, those penalties are generally not asserted for eligible filers.

What about pensions holding the same funds?

Pensions sit outside the PFIC rules in most cases. Funds held inside a UK workplace pension or a personal pension are generally protected by the treaty, so the punitive regime does not reach them. That is why pensions often make better homes for pooled funds than an ISA does.

The protection depends on the scheme qualifying under the treaty. Most mainstream workplace and personal pensions do, but unusual arrangements deserve checking before you assume it.

So the practical planning point is simple. Keep the funds in the pension, and keep the ISA for shares, cash or something America does not treat as a PFIC.

Mistakes and penalties we see with PFIC holdings

• Assuming the ISA wrapper protects the funds from American tax.
• Holding a small legacy fund for years while the interest charge grows.
• Selling inside the wrapper and reporting nothing on the American return.
• Buying the same type of fund again after cleaning up the portfolio.
• Missing Form 8621 for a year with no sale, which the rules still require.
• Making an election late, then discovering it needed a timely filed return.

The direct penalties here are less alarming than the arithmetic. A modest fund can produce a tax bill out of all proportion to its size, purely because of how long it sat untouched.

How US UK Tax Accountants helps

We model each holding three ways, sell, elect or purge, and show you the numbers before anything happens. Then we prepare the forms and the elections with the return. If you hold British funds and file in America, get in touch with a portfolio valuation and we will map the cleanest route alongside your US federal returns.

Last reviewed 23 September 2026. This article is general information and not personal tax advice. Elections have strict timing rules, so take advice on your own holdings before filing.