When you sell mutual fund shares, you trigger a tax event -- a capital gain or loss. Using the sale proceeds to buy shares in a different mutual fund does not affect your tax situation from the sale of shares. You can defer or escape the tax implications of mutual fund trades by holding your shares in an individual retirement account.
Every time you buy shares in a mutual fund, the fund company makes a record called a "tax lot." This shows the number of shares, purchase date, price per share and any fees or commissions. When you later sell shares, the fund company matches your sales order to your tax lots to determine your gain or loss. Your cost basis is the amount you paid for the shares. You can have the fund match tax lots on a first-in, first-out basis; by individual identification of lots; or by the average cost of all shares.
Capital Gains and Losses
You figure your capital gain or loss from the proceeds of the sale minus the shares' cost basis, as identified by the tax lots. Any fees add to your cost basis. For shares you held a year or less, the short-term capital gains tax is your marginal tax rate. If your modified adjusted gross income exceeds $400,000 as an individual or $450,000 as a couple, the long-term capital gains rate is 20 percent, as of 2013. If your MAGI is lower, you pay 15 percent if you are in a 25 percent or higher tax bracket. Otherwise, your gains are tax-free. Capital losses offset capital gains and up to $3,000 of ordinary income. You can carry over unused capital losses to future tax years.
If you repurchase shares in the same fund within 30 days of the sale, you have a wash sale and you cannot deduct any loss arising from it. Some funds have deferred sales fees that charge you for selling shares within a certain period. You can subtract these fees from the sale proceeds, which reduces your taxable income or increases your loss. If you sell all of your shares, any reinvested dividends, interest and capital gains will be included in your proceeds, which may increase your taxable income. You will also receive any accrued interest or dividends, which will also increase your taxable income. You treat any capital gains from mutual fund distributions as long-term.
Buying New Funds
When you buy shares in a new fund, you restart the clocks for capital gains and any deferred sales charges. You will have to pay any sales fee or commission on the new shares, increasing your cost basis. You might escape a new sales fee if you exchange shares within the same mutual fund family. This is called a reinvestment right and may limit the tax benefit of sales loads if you sell the shares within 90 days of purchase. When you buy into a new fund, you can expect to receive additional tax forms reporting your dividends and capital gains after the year ends. That means more paperwork.
If you buy and sell shares within a traditional IRA, you postpone taxes until you make withdrawals. The tax rate is your marginal tax bracket. If you use a Roth IRA, qualified withdrawals are tax-free. IRAs save you the bother of detailed tax reporting on your mutual funds.
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