What is Capital Gains Tax

Mutual fund investors incur taxation at several levels. First taxes are levied on the profits the fund makes while the investor holds it (the so called capital gains tax). The second type of taxes levied is observed when investors sell the shares of the mutual fund s/he owns.

Capital Gains = purchase price of asset - selling price of asset (positive result)

Capital Loss = purchase price of asset - selling price of asset (negative result)

Types of Capital Gains

Generally, there are two types of capital gains:

1. Unrealized gains

   Unrealized gains are not taxed until they are distributed to the investors since they are gains presented only on paper. In case the securities in which a mutual fund invests appreciate and the fund does not sell them, taxes will not be paid on the part of shareholders.

2. Realized gains

   Realized gains are taxed whenever the assets have appreciated to the desired levels and are sold by the fund. A tactic applied by portfolio managers for the purposes of reducing tax burden on capital gains is the offsetting of profits by the losses incurred by another stock.

Capital Gains Categories

Capital gains can be classified as:

1. Short-term

   The investor holds the assets for no more than one year. Gains from the short-term category incur the same tax levels as your income does. 

2. Long-term

   The investor holds the assets for more than one year. The tax rates incurred in this category of capital gains is greater than 5% but doesn't exceed 15%. The value is determined by the tax bracket in which the investor falls. The good news is that as for 2008, the tax rate on long-term capital gains will be zero to tax-payers falling in the lowest tax brackets.

It is recommended to invest in stock funds that experience lower turnover rates. The reason for this is that such funds hold stocks for longer periods of time and thus provide for potentially higher gains. Growth stock funds also apply the strategy of frequent buying and selling and in this way keeping taxable gains at minimums. Bonds have become less attractive point of investment since their gains are being taxed as ordinary income.

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