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<I have a question about tax-exempt bonds.
I'm assuming that the dividends are what are tax emempt -- and not any capital gains/losses you may have when you sell the fund (I'm talking about bond funds here).>

You are talking about bond funds here.

You live in WA State, which doesn't have a state income tax. To make the answer more general to other readers, I will include states that do have a state income tax.

Although a bond fund pays a "dividend," this dividend is taxed as if it is interest (ordinary income tax rates). Bond fund interest "dividend" do not get the lower tax rate of qualified stock dividends.

Treasury interest is state tax exempt, but not federal tax exempt. (This is important in high tax states, such as Oregon.) For you, living in WA State, this is not tax exempt.

Municipal bond interest is Federal tax exempt. If you lived in a state with an income tax, muni interest would only be state tax exempt if you lived in that state. That's why Vanguard has separate CA, NY, etc. muni bond funds. For you, living in WA State, the federal tax would be exempt. The state and local tax exemption would not apply to you. This is shown on a 1099-DIV form, but it is reported as tax-exempt interest income -- your tax prep software will have a box for that.

Capital gains are treated as such. If you bought a share of a bond fund with NAV of 10 and sold it at 12, the $2 of capital gains would be taxed short/long, as if it was a stock fund. Mutual fund companies, such as Vanguard, send a 1099-B that shows the average cost and sale price of shares, which shows the capital gain and makes it simple to fill in the Schedule D.

Wendy
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