A mutual fund is a pooled investment. This means the investment company gathers funds from a number of different investors, pools the money together and uses the total amount to invest in a wide variety of different securities, typically stocks and bonds. Mutual funds provide investors with two important qualities: professional management of funds and diversification of investments. Like most investments, there are tax consequences to trading in mutual funds.
Mutual Fund Pricing
Mutual funds may be sold through investment brokerage firms, but they are sold by the mutual fund company. There is no secondary market for mutual fund shares. Fund shares trade at their net asset value, or NAV, which is derived from the value of all the investments held by the fund, minus any fees and expenses charged by the fund's management, divided by the number of outstanding shares in the fund. The NAV is typically figured once per day at the end of trading.
Buying Mutual Fund Shares
Different mutual fund companies offer shares of their funds in different ways. Some funds allow investors to purchase directly from the company, while others require investors to go through a broker or sales representative. Some funds charge a sales charge, or load, when you purchase shares of the fund. These are called load funds. Some funds do not have a sales charge. These are called no-load funds. The amount you paid for your shares of the mutual fund, plus any sales charge, is your cost basis for federal income tax purposes.
Holding Mutual Fund Shares
You do not incur any tax obligation by purchasing the shares of any mutual fund, but there may be tax consequences for holding shares of a mutual fund. Securities within your mutual fund may pay dividends or interest. Fund management may buy and sell securities within the fund which result in a capital gain or loss. These gains, losses, dividends and interest are passed on to all fund shareholders on a pro rata basis, regardless of whether the fund makes a distribution to you or if you have any gains automatically reinvested. You are responsible for paying any resulting taxes.
Selling Mutual Fund Shares
The Internal Revenue Service considers shares of a mutual fund to be an investment security, and gains or losses resulting from the sale of mutual fund shares are taxed accordingly. Figuring your gain or loss on the sale of mutual fund shares can be complicated if you purchased shares of the fund at different times and at different prices. The IRS uses a first-in, first-out accounting method for mutual funds. If you purchased 100 shares of a mutual fund per month for five months, and paid a different price each month, your cost basis would be different for each block of shares. If you sold 400 shares at one time, you would have to figure the gain or loss based on the first 400 shares that you purchased.
- Internal Revenue Service: Publication 550, Sales and Trades of Investment Property
- Securities and Exchange Commission: Investing Basics Mutual Funds
- Internal Revenue Service: Mutual Funds (Costs, Distributions, etc.)
- World Wide Web Tax: Do I Have to Pay Tax on my Mutual Fund Dividends and Capital Gains?
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