22 What are the tax implications of mutual funds for individuals?
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This article is from the FAQ, by with numerous contributions by others.
22 What are the tax implications of mutual funds for individuals?
Like shares of any stock, selling mutual fund shares may cause you to
realize a capital gain or loss. Mutual funds also distribute dividends
received and their own realized capital gains, usually at the end
of the year; these distributions, whether taken in cash or reinvested,
are taxable (note that the nontaxability of municipal bond funds
applies only to dividend distributions; capital gain distributions
are always taxable). Thus it is often a bad idea to buy a mutual
fund just before the distribution date, since part of your investment
will be immediately returned to you as a taxable distribution, resulting
in you paying taxes much earlier than if you bought just after the
distribution. Although the distribution lowers the net asset value
of your shares, allowing you to "deduct" it when you sell the shares,
paying taxes sooner rather than later prevents you from gaining
investment income on the amount that is taxed. Note that reinvesting
is considered identical to taking the distribution in cash and
sending the same amount into the fund as a new investment, so don't
forget about it when calculating the basis in your account. When
selling, it is best to know the different methods of calculating
the basis of shares sold ahead of time, since some methods require
that you designate which shares are to be sold. For more information,
call 1-800-TAX-FORM and ask for publications 544, 550, and 564, and
schedules B and D, but note that tax rules can change since the last
tax year.
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