Your first reaction might be to sell the oldest shares, so that the sale is treated as a long-term gain, and subject to the lowest capital gains rate.But the oldest shares are probably the cheapest that you purchasedmeaning their profit is the highest.Thus, even if you might have owned the fund for just a month or two, and even though you have not yet sold the shares of your fund that you originally bought, its quite possible that you could receive a long-term capital gain distribution.
All this leads to a surprisingly common mistake among mutual fund investors: They pay taxes twice on their mutual fund profits.
Ill bet this is true even for those who automatically reinvest their distributions.
Heres how it happens: Lets say Casey invests $10,000 into a bond fund that pays an 8% annual dividend, or $800.
Casey automatically reinvests this $800 and the fund gives him more shares.
Clearly, the shares you sell will determine your tax liability.
The problem is that most investors dont know that they have a choice. But make your selection carefully, for once you pick a method, you cannot change it for that particular investment.
But the IRS says all reinvested dividend and capital gain distributions count as investments, too.
Therefore, when Caseys accountant asked how much Casey invested, Caseys answer should have been ,000not ,000!
At the end of the five years, his fund would be worth ,000 (his original investment of ,000 plus the ,000 in dividend reinvestments).
Thus, if Casey were to sell his fund, he would receive a check for ,000.
Which shares did you sellthe ones you bought 10 years ago, the ones you acquired most recently, or those in between?