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I'm new to mutual funds--currently the only ones I own are part of my 401ks. Several of us small investors around the office have been discussing the distributed capital gains that holders of non-tax-protected mutual fund shares pay each year.

Sooner or later, you'll end up selling your shares of the fund--hopefully for a lot more than you paid all those years ago. Do you have to pay long-term capital gains on the difference between the original purchase price of the shares and the eventual sale price? Or does the cost basis of the shares get adjusted every year as part of the capital-gains distribution routine?

And if it's the former and not the latter, isn't that double taxation?

My apologies if this has already been answered on the board. I searched, but couldn't find it...
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Some basic questions that all mutual fund holders should understand thoroughly. There are four different ways to calculate cost basis when you sell shares. You need to keep detailed records or use a tool such as Quicken. Personally, I keep a log sheet for each taxable fund I own, so at a moment's notice I can see what my cost basis is.

www.fairmark.com explains this all very well.
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Sooner or later, you'll end up selling your shares of the fund--hopefully for a lot more than you paid all those years ago. Do you have to pay long-term capital gains on the difference between the original purchase price of the shares and the eventual sale price? Or does the cost basis of the shares get adjusted every year as part of the capital-gains distribution routine?

And if it's the former and not the latter, isn't that double taxation?

No. It isn't double taxation.

Every time capital gains are distributed, the asset value of the shares decreases. If a fund never distributed gains, when you eventually cash out, you would have to pay taxes on a much greater total capital gain. The distribution just forces you to pay for a portion of your capital gains now, rather than later. Since the share value takes a step backwards when distributions occur, the capital gains tax you pay now, will effectively reduce the amount you would otherwise have owed later.
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The distributions are the gains the fund made through selling off shares or dividends/interests some of the stocks/bonds in the fund earned. They have to be distributed to the investors in the fund.

You can choose to be paid cash or have the distributions reinvested. You pay taxes on those distributions. Some are long-term gains, some are short-term gains.

When you sell X number of shares at some price you will recive a certain amount of proceeds. From this amount you will subtract your cost basis to determine how much capital gains (or loss) you have. This basis includes the checks you send to the fund and it includes all those distributions that were reinvested.

Just remember that for Schedule D purposes you have to separate the shares that you owned for less than a year from those you owned longer than a year.

Does that help. I just learned this in the last month myself.

c130king
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