Nov 11, 2015 Capital Gains – FAQs

What is a capital gain?

A capital gain is the profit when you sell a capital asset, such as stocks, bonds, mutual funds or property. The profit is your gain over the original price you paid and you must pay tax on that gain. For example, if a stock is bought at $50 and later sold at $100, the capital gain is $50.

What rate would apply to my capital gain distribution?

Long-term capital gains apply when you hold an asset for more than 1 year. You pay a different rate based on your Marginal Tax Bracket. Long Term Gains will be taxed at 0% if you are in the 10%-15% tax bracket, they are taxed at a rate of 15% for the 25%-35% tax bracket, and taxed at 20% for the 39.6% tax bracket. Short-term capital gains apply when an asset is held for less than 1 year and are taxable at your ordinary income rate. For example, an investor that has a long-term capital gain of $1,000, and is in the 25%-35% tax bracket, must pay 15% tax on the $1,000 capital gain which is $150.

Why do mutual funds pay capital gains?

When a mutual fund sells a security within the fund, the sale also creates a capital gain. Mutual funds are required by law to distribute virtually all gains to shareholders. This prevents the gains from being taxed at the Trusts Tax bracket (40%). For example, if you own mutual fund ABCDE and mutual fund ABCDE bought stock XYZ at $20 and later sold it at $100, mutual fund ABCDE is required to distribute the $80 in capital gain to you, the shareholder. You are then responsible for paying tax on the $80 capital gain.

How can I have capital gain distributions when my mutual fund is down during the year?

The capital gain distribution reflects the gains recognized by the trading activity of the fund manager during the year, which in turn is based on when and at what price the manager originally purchased the stock. So even though the mutual fund’s portfolio may be down for the year, the sale of the securities by the fund’s manager can still result in capital gains, particularly if they have been held in the portfolio for a long time. For example, mutual fund ABCDE owns only one stock, XYZ. It bought stock XYZ five years ago at $20. Stock XYZ began this year at $150 and finished the year down 33% to $100. The portfolio manager decides to sell XYZ at $100 realizing an $80 long-term gain (based on $20 initial purchase price) and also takes a negative return on the year. In other words, ABCDE had a 33% loss for the year and distributed $80 in capital gains to the shareholder. Now if you bought the fund just that year for $150, your basis increases by the $80 distribution. If you sold the shares for $100, you would be able to take a tax loss of the $50 difference in price plus the $80 distribution for a total loss of $130.

Can I offset my capital gain distributions?

Yes. Losses on your investments are first used to offset capital gains of the same type. So, short-term losses are first deducted against short-term gains and long-term losses are deducted against long-term gains. Net losses of either type can then be deducted against each other. So, if you have $5,000 of short-term loss and only $2,000 of short-term gain, the extra $3,000 of loss can be deducted against long-term gain. If short- and long-term losses exceed all of your capital gains for the year, up to $3,000 of the excess loss can be deducted against other kinds of income.


The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.   Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Leonard Rickey Investment Advisors, PLLC (LRIA), a Registered Investment Advisor and separate entity from LPL Financial.

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