Mutual funds are a convenient way to own a lot of different investments through a single purchase. Rather than buying 100 different stocks, for example, you can simply buy one stock mutual fund and own pieces of all of those companies at once. When it comes time to sell your mutual fund shares, the Internal Revenue Service treats your sale the same as it would if you sold individual stocks.
Long-Term Capital Gains
You'll get the best tax rate if you can hold your mutual shares for a long time, rather than trading them frequently. The IRS levies a special discounted tax rate, the long-term capital gains rate, for assets you hold longer than one year. As of 2012, the highest long-term capital gains rate was 15 percent. However, if your federal tax rate is below 15 percent, then your long-term capital gains are taxed at 0 percent.
Short-Term Capital Gains
Short-term capital gains are those held for one year or less. The IRS treats short-term capital gains as ordinary income, so you'll have to pay the same tax rate on your short-term gains as your taxable wages, salary and other income. As of 2012, that rate could be as high as 35 percent, if you were married filing jointly with a taxable income of above $388,350.
Unless you buy a no-load fund, you might have to pay a commission to your mutual fund company when you sell your shares. Class B shares charge you a declining commission when you sell your fund, depending on how long you've held the shares. For example, you might trigger a 5 percent penalty if you sell your Class B shares in the first year after you buy them, or a 3 percent penalty after two years. Most B-share commissions decline to zero after about six years. Other share classes may also carry back-end commissions, such as Class C shares you sell in the first year.
Most fund companies allow you to exchange from one fund to another in the same fund family without paying a sales charge. However, from the perspective of the IRS, your fund exchange is actually a sale of the first fund and a purchase of the second fund. As a result, you'll have to pay taxes if you have a gain at the time you exchange a fund.
Selling a mutual fund can sometimes provide a tax benefit, rather than a tax penalty. If you sell or exchange your fund at a loss, you can use that loss to offset any other gains you have on your investments. If you have no losses, or have more losses than gains, you can apply up to $3,000 of those losses to lower your ordinary income.
- Stockbyte/Stockbyte/Getty Images