Investors who buy and sell real estate are likely well versed in capital gains, which are the profits derived from the sale of investment properties that commanded a higher price than your original basis.
Capital gains are divided into long- and short-term gains. Long-term capital gains are generated on the sale of investment properties you held for longer than one year, while short-term gains are generated on the sale of assets held less than 12 months.
Capital gains distributions, however, are much different. Shareholders of mutual and exchange-traded funds (ETFs) may receive capital gains distributions from these investment vehicles. Keep reading to learn more about these distributions and how they are treated at tax time.
How Capital Gains Distributions are Taxed
If you are a shareholder in mutual funds or ETFs, you may realize two types of capital gains.
You will incur either long- or short-term capital gains if you sell your shares of a fund for a higher amount than you paid to acquire the shares. Long-term capital gains are taxed at 0, 15, or 20 percent depending on your income and filing status. Short-term capital gains are taxed at your nominal tax rate.
You may also incur a tax liability from capital gains distributions. Here’s why.
Capital gains distributions occur when an ETF or mutual fund sells stocks or other assets held in its portfolio for a profit. These gains are distributed to investors based on their pro-rata ownership share of the fund or ETF. Investors can opt to either take these proceeds as a payment or to reinvest them back into the fund or ETF to increase their pro-rata shares. Either way, investors are required to pay taxes on these capital gains distributions, and those taxes are due in the same tax year the distribution was made and received. However, if you own those shares inside of a tax-deferred 401(k) or IRA, the taxes will be due when you begin drawing down funds in your retirement.
According to the Internal Revenue Service, capital gains distributions from pooled investment vehicles are taxed at the more favorable long-term rate regardless of how long you've held shares of the mutual fund.1 The amount received during a tax year will be shown on box 2a of Form 1099-DIV. When preparing your tax return, your accountant or tax professional will enter this amount on line 13 of your Schedule D.2
Putting it all Together
Investors who own shares of pooled investment vehicles such as mutual funds or exchange-traded funds must pay taxes on any capital gains distributions they receive. These distributions differ from any quarterly or annual dividend payments you may receive because they are generated by the fund from the sale of capital assets held within the fund.
You can choose to take a capital gains distribution as cash or reinvest it back into the fund to increase the number of shares you own. Regardless, you’ll have to pay long-term capital gains taxes on any capital gains distributions, and taxes are due in the reporting period in which they were received unless your shares are held within a tax-deferred IRA or 401(k).
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds or ETFs. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
