<p>I am very smart in some ways, but really stupid when it comes to taxes. </p>
<p>We had a mutual fund for years that was not doing well, and we sold it periodically when we needed cash, to get rid of it. Last fall we sold the remaining $18k and bought a tax-free mutual fund instead. Now we have to pay taxes on the sale, except that we lost money. (Yes, I know that my tax return is very late, but I paid up on time in April, and got an extension. I am somewhat late in filing, but they will owe me a refund so I hope not to get carted off to jail.) I finally got all the records together and figured out how much we lost.</p>
<p>In the past, when we sold this fund, I used a first-in, first-out method. So for this final sale, I started with most recent acquisitions (from dividend and capital gains distributions) and worked back until I had all the shares that we sold last year. We lost over $10k!</p>
<p>I know that we can offset any capital gains with this loss, but we don’t have any for 2008. I think that we can offset regular income, but I don’t know how much. </p>
<p>One thing I have never understood is this: every year we have to pay taxes on the dividends and capital gains. Then when we sell, we pay taxes again (except for this last sale)! Aren’t we being taxed twice?</p>
<p>You pay taxes on realized capital gains as they’re realized by the mutual fund. This happens in the normal course of the fund buying and selling stocks. Say the fund owns 100 shares of IBM that it purchased for $100 and sold for $125. The fund has a capital gain of $2500. Your portion of the gain will be shown on your end-of-year statement for that fund. Funds that churn stocks tend to have high capital gains (and/or losses) than funds that buy and hold over the long term. You pay taxes on these gains in the year they’re realized by the fund. </p>
<p>When you cash out of the fund, the fund company gives you a statement (Form 1099-DIV) showing the purchase price of all shares, which you can then use to determine your overall gain or loss. If you bought 100 shares of the fund at $50, sold them at $30, then your capital loss would be $2000. But in the meantime you’ve probably been reinvesting dividends so you have additional shares purchased over time at different prices, all of which should be on your statement. You’ll need to know the cost basis of those shares to determine the exact gain or loss. You can use FIFO or other methods to calculate gains/losses. Once you start with FIFO, you need to be consistent in your future accounting and continue to use FIFO for the rest of the shares.</p>
<p>When you have a capital loss, you can use it to offset any gains for that tax year. If you have no gains to offset, you might still have a net loss. You can claim up to $3000 of that loss on that year’s taxes and carry over the rest, to be used to offset any gains in the following year. So in 2008 you can declare $3000 in capital losses, and have the remaining $7000 carried over to be used on your 2009 taxes.</p>
<p>Hope that helps - mutual funds can be confusing!</p>
This is the only part I’d disagree with. The 1099 DIV is issued every year, whether you cash out or not. It shows the taxable dividends and capital gains whether reinvested or not. The 1099 B shows the gross proceeds when you cash out and a few, but not many, mutual funds will show cost basis. And if they do, it will be on an average cost method. The OP can’t use that method since they started with FIFO, so should continue recalculating in their own way.</p>
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You shouldn’t be. When you sell, you take the original purchase, plus reinvested dividends and capital gains as the basis. Eventually, whatever method you’re using, all the purchases plus dividends would have been used up and you would pay tax only on gains.</p>
<p>Back in 2001 (remember the “tech bubble” bust?) I decided I couldn’t sit around and watch some of my stocks go to zero and I took a $30k loss. It has been just wonderful taking that $3000 writeoff every year. I used the balance last year against the capital gain from selling my house. </p>
<p>Your complaint is a very common one: A mutual fund looses value during the year, yet throws off taxable distributions. You have lost money on your investment, but you owe taxes! Annoying, but happens all the time. I guess if you owned an individual stock that dropped in price but paid a dividend you would be in the same situation.</p>
<p>To answer your last question, you are not taxed twice. When your mutual fund distributes dividends or capital gains, the price adjusts down, so that reduces your sale price relative to your cost when you do sell.</p>
<p>You are allowed to take $3,000 of capital losses every year as a reduction in your overall taxable income. Of course, many many people are in this situation in the 2008 and 2009 tax years. Any beyond that you carry over to the next year, and it’s up to you to remember it.</p>
<p>What a succinct explanation, vballmom! And thanks for the additional information, everyone. It is a relief that, at least, I will be able to get a tax deduction on regular income. But is that cheating, in a way? The gains from the mutual fund in previous years were taxed at preferential rates. Now the loss will be sheltering income, which is taxed at much higher rates. Or am I missing something?</p>
<p>Well, this advantage is offset by the fact that you can’t use any but $3,000 this year. In future years, if you have capital gains, the remaining loss kitty must be used to offset those gains (which could be long-term lower-taxed gains) first.</p>