Mutual Funds

Stock mutual funds are a little complicated when it comes tax time.

Throughout the year, the mutual fund will buy and sell securities in an effort to increase the value of the fund and generate capital gains as a result. To avoid paying tax, mutual funds generally pass along almost all of their capital gains to their shareholders once a year.

How are Mutual Funds Taxed?

Distributed short-term capital gains are taxed as ordinary income and distributed dividends and long-term capital gains are taxed as long-term capital gains.

When you sell shares of a mutual fund for a higher price than you paid, you pay either a short- or long-term capital gain tax, depending on how long you own the shares.

For example, if you receive a capital gain distribution and then incur a short-term capital loss on a sale of mutual fund shares you held six months or less, the IRS has a special “Short-Term Capital Loss” rule that applies.

Wash Sales and Mutual Funds

The IRS has created several rules in order to discourage loss-oriented selling, such as the wash sale rule. According to this rule, if you purchase shares of a mutual fund (including reinvested dividends) within 30 days before or after you redeemed shares of the same mutual fund for a loss, the redemption is considered a "wash sale" and some or all of your capital loss will be deferred. The amount of your deferred loss increases the cost basis of the shares purchased within the 30-day window.

Mutual Fund Dividends

Tax reports such as Form 1099-DIV (Dividends and Distributions) from mutual fund companies usually specify the amount of total ordinary dividends (including dividends, interest and short-term gains) and total long-term capital gains. Due to provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003, if a mutual fund receives qualifying dividends from a stock that it holds and passes these onto its shareholders, recipients will be able to apply new, lower tax rates to those dividends. Therefore, mutual fund companies should also report separately the dividends that qualify for the lower rates. This makes reporting capital gain amounts on the appropriate IRS Form 1040 return or Schedule D much easier.

TradeLog helps active traders generate accurate tax reporting.

Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.