Mutual Fund Accounts - Selling Mutual Fund Shares

The following information details all of the issues that must be taken into account for calculating the tax impact of selling mutual fund shares.

  1. Tax Rates
    • Capital gains - This refers to income resulting from the appreciation of a capital asset (such as mutual funds and stocks). Capital gains are not realized until the asset is sold. Capital gains are classified as short term or long term:
      • Short term - Assets held for 12 months or less are considered short-term capital gains and are taxed at ordinary income rates.

      • Long term - Assets held for longer than 12 months benefit from reduced tax rates (based on your marginal tax bracket). Those in the lowest tax brackets (10% or 15%) pay only 5% capital gains tax rate, while those in the higher brackets (25% and above) pay only 15%.

    • Dividends - Prior to 2003, dividends were taxed at ordinary income rates along with bond interest. Due to a change in tax law, "qualified" stock dividends (common and preferred) are now taxed like capital gains, with a maximum income tax rate of 15%. Real estate investment trust (REIT) dividends do not qualify for this special treatment.
  1. Holding Period
    Because the difference between short-term capital gains and long-term capital gains taxation rates is so significant, it is crucial to understand exactly when a security is considered purchased and when it is considered sold.

    The holding period begins the day after the security is purchased (not the settlement date) and ends the day of the sale. It is important to keep detailed records of these dates to ensure that a security is not sold too soon.

    If mutual shares were purchased on more than one date, there are several ways to calculate the cost basis of the shares sold:
    • Specific identification - The investor may choose to sell specific shares in order to minimize or maximize cost basis and therefore capital gains (or losses).
    • First-in/first-out - If the investor does not specify which shares were sold, the IRS presumes that the shares held longest were sold first.
    • Average share cost - This is the method used when selling all shares at once.
  1. Cost Basis
    A key concept to understand in computing gains and losses is cost basis, because the amount of capital gains to be taxed is calculated by subtracting the investor's cost from the sales proceeds. To determine the cost basis of an investment, start with the original price (plus any transaction costs). Next, add the dollar value of dividends that were reinvested. This applies to both stocks in a dividend-reinvestment program and mutual funds where dividends are automatically reinvested. Reinvested capital gains are also added to the cost basis for mutual funds.


  2. Netting Capital Gains and Losses
    • Net short-term gains against short-term losses.
    • Net long-term gains against long-term losses.


Opening a New Account and Account Types

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