basic mutual fund question (pay, taxes, account, increase)

[foxboro82]

Let's say 5 years ago you put $5000 post-tax money in a mutual fund. And today it is worth $6500.

You want to:

1. Take out $1000. Are you charged capital gains on the full $1000?

2. Cash out the whole thing. Will you pay capital gains on the entire $6500 or just the $1500 you made with the investment?

Thank you for any info

[mathjak107]

You are only taxed on the money you take out. profits are your cost less any re-invested dividends and capital gains distributions.

[Thepreacherswife]

1. Assuming no dividend reinvestments, you'll only pay capital gain taxes on a percentage of the $1000 that represents the increase in value: (1000 x (6500-5000)/5000, or $300. The rest of the $1000 is considered a return of your original investment.

2. Just the $1500.

[foxboro82]

Thank you!

I have the settings for my fund where dividends are reinvested. How does that affect the scenarios?

[mathjak107]

as long as we are talking a taxable account and not an ira or 401k then you already paid taxes each year on those distributions so they get added to your cost basis.

that lessens the tax due. think of it as if you added more money raising your cost basis.

[Thepreacherswife]

Originally Posted by foxboro82

Thank you!

I have the settings for my fund where dividends are reinvested. How does that affect the scenarios?

It just makes the calculation a bit more complicated. There are three different ways to calculate the gain/loss for tax purposes when you sell shares:

1. FIFO (first in, first out). This assumes that you sell your oldest shares first.

2. Weighted average. This method assigns a weighted average value per share by taking your initial investment, adding the amounts of dividends reinvested, and dividing that number by the number of shares you hold in your account. Every time you make an additional purchase or have a dividend reinvested, the weighted average value per share changes, but it's not necessary to recalculate until you sell.

3. Specific identification. This means you tell your broker or mutual fund company (before the sale) which particular shares you wish to sell (if you want to minimize gain, for example, and you have different lots of shares purchased at different times at different share prices). The broker or mutual fund company must confirm your identification of the specific shares in writing.

I believe that FIFO is the default method. If you choose weighted average for any sale, I think you're stuck with that method for as long as you hold the fund.

IRS publication 550 has all the gory details.

Publication 550 (2012), Investment Income and Expenses

[michgc]

ThePreachersWife, you always give great explanations. Thank you!

[snowdenscold]

Originally Posted by Thepreacherswife

1. Assuming no dividend reinvestments, you'll only pay capital gain taxes on a percentage of the $1000 that represents the increase in value: (1000 x (6500-5000)/5000, or $300. The rest of the $1000 is considered a return of your original investment.

2. Just the $1500.

Good explanation, but you made an typo/error from going too fast probably

Wouldn't the denominator of your fraction there be 6500, not 5000?

So 1000 x [ (6500 - 5000) / 6500 ] = $231.



Or another way to think about it is let's say you bought 100 shares at $50, and now each share is worth $65. At $1000, you're planning on selling about 15.4 shares. So those 15.4 shares each made a $15 profit, so your CG is 15.4 x 15 = $231.

[Thepreacherswife]

Originally Posted by snowdenscold

Good explanation, but you made an typo/error from going too fast probably

Wouldn't the denominator of your fraction there be 6500, not 5000?

So 1000 x [ (6500 - 5000) / 6500 ] = $231.



Or another way to think about it is let's say you bought 100 shares at $50, and now each share is worth $65. At $1000, you're planning on selling about 15.4 shares. So those 15.4 shares each made a $15 profit, so your CG is 15.4 x 15 = $231.

Yep, spot on.

Thanks for getting it right.