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.
    If you inherit an investment, your cost basis is the value of the asset as of the decedent's date of death. This is known as a stepped-up cost basis. Also, the holding period is always considered long-term, even if the deceased hadn't owned the investment for 12 months before death.

    If you receive an investment as a gift, there are actually two different cost bases that apply: the actual cost basis of the giver and the market value on the date of the gift. The best way to explain how this works is to use an example. Let's say you are given shares of a mutual fund, and the original owner's cost basis was $70 a share. On the date of the gift, the shares are trading at $60. If you sell the shares in the future, the basis for a gain is $70 a share, and the basis for a loss is $60. If you sell the shares for between $60 and $70, you have neither a taxable gain nor a taxable loss.

  2. Netting Capital Gains and Losses
    If an investor makes a number of trades in a particular year, the end result could be a mix of long-term and short-term capital gains and capital losses. The IRS is specific as to how these gains and losses are to be netted against each other. Here are the steps:
    • Net short-term gains against short-term losses.
    • Net long-term gains against long-term losses.
    • If both holding periods result in gains (or both in losses), they are reported separately on Schedule D.
    • If one holding period results in a gain and the other in a loss, they are then netted against each other.
    • If capital losses exceed capital gains, up to $3,000 can be deducted against ordinary income in any one year.
    • Unused capital losses can be carried forward indefinitely to future years - each year, unused capital losses will first be netted against the current year's capital gains, followed by the $3,000 deduction against ordinary income.

There are a number of occasions that may result in an investor moving shares of one mutual fund to another. If done within the same mutual fund family, this is known as an exchange. From the investor's point of view, a sale has not occurred - but the IRS does consider this a sale. Therefore, capital gains must be calculated and taxes paid. As a result, the cost basis in the new shares is simply the net asset value of the shares that were purchased.

Opening a New Account and Account Types
Related Articles
  1. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  2. Investing

    Latin America’s Economic Forecast

    After a ten-year run, the economies of Latin America are in a decline. For sustainable, long-term growth, the region needs structural reforms.
  3. Professionals

    Illiquid Real Estate: Correlation Pros and Cons

    Stock and bond markets are moving more closely in tandem with each other. Is illiquid real estate the vaccine for this correlation?
  4. Professionals

    How to Manage Fixed Income as Interest Rates Rise

    A look at how to manage fixed income amid the specter of rising rates, correlation to stocks, client expectations and more.
  5. Mutual Funds & ETFs

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  6. Economics

    Why the Euro Failed to Become the World's Reserve Currency

    Examine the current state of the U.S. dollar as the world's reserve currency; learn the major reasons why the euro has failed to replace it in that capacity.
  7. Mutual Funds & ETFs

    4 Mutual Funds Warren Buffet Would Buy

    Learn about four mutual funds Warren Buffett would invest and recommend to his trustee, and discover detailed analysis of these mutual funds.
  8. Investing

    The Top Businesses Nurtured By Y Combinator

    We look at the top startups that were incubated at Y Combinator, one of the world's most popular business incubator firms.
  9. Professionals

    Want to Start Up an RIA? Expect These Hurdles

    RIAs looking to strike out on their own need to overcome and plan for a number of hurdles.
  10. Investing Basics

    Are ETFs the Best Way to Diversify with Bonds?

    Are bonds safe or risky right now? It depends on the type of bond and how you invest in them.
  1. Unicorn

    In the world of business, a unicorn is a company, usually a start-up ...
  2. Private Equity Real Estate

    A Definition of "Private Equity Real Estate" and how it applies ...
  3. Put-Call Parity

    A principle that defines the relationship between the price of ...
  4. Encumbrance

    A claim against a property by a party that is not the owner. ...
  5. EBITA

    Earnings before interest, taxes and amortization. To calculate ...
  6. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  1. Are Cafeteria plans taxable?

    Whether the benefits you receive through your employer-sponsored cafeteria plan are taxable depends entirely on which benefits ... Read Full Answer >>
  2. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
  3. How do mutual funds compound interest?

    The magic of compound interest can be summed up as the concept of interest making interest. On the other hand, simple interest ... Read Full Answer >>
  4. Who decides to print money in Russia?

    The Central Bank of the Russian Federation (CBRF), like its peers in most countries, is the governmental entity responsible ... Read Full Answer >>
  5. Does working capital include prepaid expenses?

    The calculation for working capital includes any prepaid expenses that are due within one year, since such prepaid expenses ... Read Full Answer >>
  6. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
Hot Definitions
  1. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  2. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  3. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  5. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  6. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!