How does Capital Gains tax affect me?

If you listen to any conservative talk shows long enough, whether it be Rush Limbaugh or Bill O’Rilley, you’re bound to hear the topic of capital gains tax brought up. From listening to these pundits, you would think capital gains is the most evil form of taxation known to man. But what is capital gains really and how does it affect mutual fund investors?

Mutual fund investors can get hit pretty hard by capital gains taxes. Breaking down the name, capital is in reference to the profit made from investing in mutual funds. A mutual fund can actually get dinged twice by capital gains tax, once when you own the shares and the fund is earning profits for you, and again on the profit you make when you decide its time to sell off the shares in the mutual fund.

The gain is simply defined as the difference between the price you bought your mutual fund for and the price you sold your mutual fund for. The gains that are associated with mutual funds are usually broken down into two different categories: realized gains and unrealized gains.

An unrealized gain is defined as a gain that you can see but you haven’t actually been paid yet. For example, let’s say you open the morning paper and see that your mutual fund has gone up 5 points and once you crunch the numbers, you realize that you made 2,000 dollars. Until this money is paid out to you, this is qualified as an unrealized gain.

A realized gain, on the other hand, is a gain that has been paid out, or realized.

Capital gains taxes can also be broken down into two different categories known as long term and short term. A short term capital gain is taxed at a different rate than a long term gain. The short term gain is usually taxed at whatever tax bracket you’re in. As for long term gains, they are usually taxed at a rate somewhere between 10 and 20 percent, depending on the tax bracket you’re in.

One positive is that your mutual fund company is required to tell you exactly how much potential tax could be taken out of your investments in their prospectus. This way, you’ll go into every investment with your eyes wide open.

Capital gains tax is isn’t a lot of fun to deal with but they are part of mutual fund investing. Recent tax laws have benefited investors by lowering the amount of tax you pay, but there is still a significant amount of tax there, and it won’t be going away any time soon.