Definition of a Mutual Fund's Short- & Long-Term Holding Period
When you receive the Form 1099 for your mutual fund's capital gains distributions, those payouts will be divided into long- and short-term gains for you to report on your tax return. The mutual fund company uses the same rules you would to determine whether a gain on an investment is long-term or short-term. A fund pays out the whole year's worth of the two types at the end of the year.
Short- vs. Long-Term Gains
The tax rules define short-term as an investment holding period of one year or less. Selling an investment that was held less than a year results in a short-term gain or loss. Investments held longer than one year and sold for a profit will produce long-term capital gains. The long- or short-term cutoff applies to investments held by a mutual fund as well as to your personal investments.
Mutual Fund Gains
A mutual fund must distribute net capital gains to shareholders at least once a year. Most mutual funds total up short- and long-term gains for the year and make the distributions during the last couple of weeks of December. The distributions reflect all of the realized profits the fund earned for the year. Capital gains distributions are the profits net of any losses the fund incurred on its portfolio.
The Fund's Holding Period
A mutual fund's determination of short- and long-term gains is based on how long it's held an investment. This might not correlate with how long you have owned shares of the mutual fund. You might have owned a fund for only a few months yet receive a long-term capital gain distribution. Conversely, a fund you've owned for years might pay you short-term capital gains distributions.
Different Tax Rates
The important difference between long- and short-term capital gains is that they are taxed at different rates. Reported short-term gains will be taxed at your marginal income tax bracket rate. Long-term gains are taxed at a lower rate. As of 2012 the maximum federal tax rate on long-term gains was 15 percent, compared to a top regular income tax bracket of 35 percent. Although you have no control over whether a mutual fund generates short- or long-term gains, you do have control over which funds you choose as investments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.