Selling Mutual Funds – Know These Tax Tips and Rules

Jennifer — Mon, 05 Feb 2007 16:08:50 +0000

Mutual funds are an easy way for people to get involved in the stock market, especially when they are new to investing or donâ€™t feel confident enough to judge market trends on their own. Mutual funds allow you turn your money over to a team of professionals, who invest in various stocks for you and manage them on your behalf. They also allow you to mitigate some of the risks of investing by compiling a portfolio of slow growing, yet solid stocks, combined with high risk, high return stocks. You can have any combination of the two you like, so your solid stocks can carry you through periods of loss on your more risky stocks. Despite all of the upfront ease of mutual funds, they have a definite downside. Mutual funds are notoriously difficult to manage when tax time rolls around; many people donâ€™t even know where to begin. The process doesnâ€™t have to be scary, though. Take some time to learn the rules, and youâ€™ll be able to tackle your mutual fund taxes with confidence.

If youâ€™re investing in mutual funds, there is one mantra you should be repeating to yourself over and over again: â€œkeep records, keep records.â€ Your record keeping can make or break you at tax time. Because mutual funds involve many trades of many different stocks every month, it is imperative for you to have a record of what stock was bought, sold, or traded when, and for how much. Most people make the mistake of believing that any income for a stock trade or sale, no matter if it is immediately reinvested, counts as income that must be claimed on your tax return. This is not so. If you keep records correctly, you can mitigate the taxes on this income, so long as it is reinvested into other stock immediately.

To keep your records in tact, you have to use a recognized accounting method for your mutual fund and stick to it. If you use the â€œFirst In, First Outâ€ (FIFO) method, then you are saying the stocks you are selling are being sold in the order in which you bought them. Aside from FIFO, there are two other methods of keeping records. With the â€œSingle Categoryâ€ method, you calculate the purchase cost of your shares and then divide that cost by your total number of share. The â€œMultiple Categoryâ€ works in much the same way, but you repeat the steps after you have divided you shares by category.

Many mutual fund companies will tell you which record keeping method you should use, and if youâ€™re just starting out in investing, it may be best to take their advice. However, once you have locked into a method, you are stuck with it for the length of your mutual fund. If you have more experience with investing, or have a financial advisor who can help you through, then you take closer look at the method you have been assigned and make sure it maximizes your tax deduction potential.

For novice traders and experienced traders alike, mutual funds can be a tax time nightmare. You can contact the IRS to get their booklets 550 and 564 for more information, but even with these resources, it is best to keep a few things in mind. Always plan ahead for tax time so you can get all the deductions available to you, and when you tax situation is complex, let a tax expert get you through the process. The investment in expert advice can pay dividends when it comes time to make out that check to Uncle Sam.

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Selling Mutual Funds – Know These Tax Tips and Rules