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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Re: Mutual Funds Gains Date: 3/21/2001 12:10 PM
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"How are gains and losses calculated for an after tax mutual fund?
Let's say I buy 50 shares of "MUTX" at $10 per share, which equates to an outlay of $500. Then as the year goes along, I receive dividends of $100 which are automatically re-invested into the mutual fund.
When I sell the shares, let's say I have 53.65 shares and the price per share is $12. I know the $100 of dividends I received are taxed as ordinary income. But, how do I figure the gains/losses since the dividends were re-invested causing the number of shares to go up. It would be easy to figure out if the dividends were not reinvested.
Hope I didn't confuse anyone. I guess I should just stay with stocks or not re-invest the dividends."

You're getting yourself in a tizzy for nothing. You just need to keep good records and be willing to do a little arithmetic.

1) Annual dividends and short term capital gains taxes generated by the fund, even if reinvested, are reported as ordinary income. Any long term capital gains generated annually by the fund are reported as long term gains. (How much and what kind of taxable distributions depend on the fund; some are tax efficient, others not.)

2) Your reinvested gains and dividends buy new shares in the fund, which will be at a different cost basis than your original purchase. You need to keep track of this from your annual statements, but it's simple accounting. I would keep a list, updated annually, in addition to keeping all the annual statements as a cross check.

3) When you sell, it depends on how you sell. If you sell the whole fund at once, you will have to calculate your average cost basis from your original shares and subsequent reinvestment of dividends. If you've held the fund for a while, this will mostly be long term capital gains, but the most recent (less than a year) reinvested gains, presuming the fund's net asset value has gone up in the interim, will produce short term capital gains.

4) If you choose to sell a bit of the fund at a time, the most tax eficient way if to sell those shares purchased at the highest price (least capital gains). You have to explicitly designate those shares to your broker or it is presumed first-in, first-out. If you choose to cost average, you're stuck cost averaging from then on.

Anyway, make your decisions about what to do with dividends based on finance (i.e., is this fund where you want to put the money?) not on fears of record keeping and arithmetic.
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