Taxation and Mutual Funds

Let's take a look at a question about mutual fund taxation . . .

All of the following are taxable in relation to a mutual fund investment except
A. undistributed capital gains
B. unrealized capital gains
C. reinvested capital gains distributions
D. capital gains distributions from a tax-exempt municipal bond fund

EXPLANATION: a surprising fact about capital gains that a mutual fund portfolio manager realizes is that even if they're not paid out to shareholders, the shareholders are taxed on their fair share of the gains. If the fund does distribute capital gains, the investor is taxed whether she cashes the check or reinvests automatically. And, municipal bonds are subject to capital gains taxes just like other securities. Of course, if a capital gain is "unrealized," there is no capital gain.



ANSWER: b

Capital Gains

Mary Ann purchased 1,000 shares of ABC on January 1st, 2009. On December 31st, 2009, she sells the shares for a $500 capital gain. If the trade settles on January 4th, 2010, which of the following accurately describes the tax consequences?
A. the gain will be considered long-term
B. the gain will be considered short-term
C. the gain will be treated as dividend income
D. Mary Ann will report the gain or loss for tax year 2010

EXPLANATION: a long-term gain happens when you hold securities for one year plus one day. As the IRS explains at http://www.irs.gov/, your holding period starts the day after you buy the stock and stops with (and includes) the day you sell it. So, if Mary Ann buys stock on January 1st, 2009, she needs to sell it no sooner than January 2nd, 2010 if she wants a long-term capital gain. Settlement has nothing to do with holding period. When you execute the sale, you no longer hold the stock. The answer is B, the gain will be considered short-term.