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Author: moneyforgolf One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121317  
Subject: another mutual fund question Date: 4/8/1998 8:59 AM
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Q. If i hold shares in a fund without adding any more cash for over 18 months, then sell it, i will be taxed at the long term rate. Then I realized that during this time, reinvested diividends and cap gains are being reinvested (but I think only put in at the end of the years) SO....then some of my money will be taxed at Short term or intermidiate rates if i sell all at once...am I correct about this?.......thanks for any thoughts.......Debbie
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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3340 of 121317
Subject: Re: another mutual fund question Date: 4/8/1998 10:40 AM
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[[Q. If i hold shares in a fund without adding any more cash for over 18 months, then sell it, i will be
taxed at the long term rate.]]

Only if your dividends are not reinvested.

[[ Then I realized that during this time, reinvested diividends and cap gains
are being reinvested (but I think only put in at the end of the years) SO....then some of my money
will be taxed at Short term or intermidiate rates if i sell all at once...am I correct about
this?.]]

Absolutely correct. When dividends are reinvested, you are actually buying additional shares of the fund at new prices and with new holding periods. The only way around this would be to elect to be PAID the dividends, rather than reinvesting them.

TMF Taxes
Roy

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Author: moneyforgolf One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3344 of 121317
Subject: Re: another mutual fund question Date: 4/8/1998 1:21 PM
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Absolutely correct. When dividends are reinvested, you are actually buying additional shares of the fund at new prices and with new holding periods. The only way around this would be to elect to be PAID the dividends, rather than reinvesting them.

Thanks ...I think I am finally starting to understand all this ...another point...if I have the dividends paid to me directly, I will still eventually have to pay ordinary dividend interest on this money at tax time, correct? So either way does it really matter which way I do it?

Also....Besides the obvious reasons why people buy mutual funds(having other people handle your money) why would someone want to pay cap gains taxes every year thru the fund and then again when we sell the shares of the fund? Aren't we actually being taxed twice on the same money or am i missing something?............thanks for your time...Debbie

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Author: DrBear One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3345 of 121317
Subject: Re: another mutual fund question Date: 4/8/1998 1:43 PM
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<<Thanks ...I think I am finally starting to understand all this ...another point...if I have the dividends
paid to me directly, I will still eventually have to pay ordinary dividend interest on this money at tax
time, correct? So either way does it really matter which way I do it?

Also....Besides the obvious reasons why people buy mutual funds(having other people handle your
money) why would someone want to pay cap gains taxes every year thru the fund and then again
when we sell the shares of the fund? Aren't we actually being taxed twice on the same money or am
i missing something?............thanks for your time...Debbie>>

Distributions from the fund (whether or not they are reinvested) are always taxable (unless this fund is in a tax-deferred plan such as an IRA). If the funds are paid directly to you, that's the end of the story. You get the cash; you pay the tax on it.

If you reinvest the distributions (dividends, capital gains, whatever) you STILL pay tax for the year they were received, but your cost basis in the fund becomes the reinvestment price for the shares. So, when you tax out, your only paying tax on the gain in these new shares. Perhaps an example would help:

12/30/97:
500 shares of XYZ @ $30/share (bought at $10.00)

12/31/97:
Fund distributes earnings:
$ 20.00 in divs
$100.00 in ST Gains (held 12 months or less)
$ 50.00 in 28% gains (held between 12-18 months)
$200.00 in LT gains (held longer than 18 months)
Reinvest Price: $28.00 (the price will drop because money formerly held in the fund is being released)

You'll pay tax on the $370 in 1997 (at a variety of rates due to the types of distribtution. That's best left to another post...).

Let's say you reinvest the money. You'll now have an additional ($370/$28)= 13.21 shares. On 3/31/98 you decide to sell all of your holdings. Your taxable gain would be calculated as follows:

3:31/98
513.21 shares sold at $32.00/sh

Gain on 500 shares = 500 x ($32-$10) = $11,000 (L/T rate)
Gain on 13.21 shares = 13.21 x ($32-$28) = $52.84 (S/T rate, because the shares were only purchased 3 months ago). As you can see, you're not being double-taxed; you're only paying on the gain since the reinvestment date. Hope this helps.

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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3402 of 121317
Subject: Re: another mutual fund question Date: 4/10/1998 10:13 PM
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[[Thanks ...I think I am finally starting to understand all this ...another point...if I have the dividends
paid to me directly, I will still eventually have to pay ordinary dividend interest on this money at tax
time, correct? So either way does it really matter which way I do it?]]

From a pure tax standpoint, it makes no difference. You'll be assessed tax on the dividend distributions regardless of if you take the distributions, or reinvest them. If you take them, you'll not have to deal with the problem of adjusting your basis for the reinvested dividends.

[[ Also....Besides the obvious reasons why people buy mutual funds(having other people handle your
money) why would someone want to pay cap gains taxes every year thru the fund and then again
when we sell the shares of the fund? Aren't we actually being taxed twice on the same money or am
i missing something?.]]

Nope. When you reinvest the shares, you are buying additional shares at new prices. So your basis in the fund is increasing everytime your dividends are reinvested. So you are only paying tax on the distributions once.

Have you read IRS Publication 564 yet? It really does explain these issues pretty well.

TMF Taxes
Roy

SPECIAL NOTE: I try to answer as many questions as I can each week, and I generally select those that have not been asked before. If you don't get a detailed answer to your question, it is probably because my time is so limited during tax season, or because it has already been asked and answered in this folder in the past, or because it has been discussed in the Taxes Frequently Asked Questions area. In order to visit the Taxes FAQ area, go to the Fool's School area (http://www.fool.com/school.htm) and check out "Other Features" in the list box, OR you can jump directly to the Taxes FAQ area (http://www.fool.com/school/taxes/taxes.htm). Additionally, if any references were made to the IRS Web Site, you can get there by pointing your web browser to (http://www.irs.ustreas.gov)


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