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Quick Index Fund Tax Question

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  • Avatar albinaire 
    Participant
    Status: Physician
    Posts: 9
    Joined: 05/02/2017
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    Quick tax question,

    Index funds (or other mutual funds) are taxed as the unrealized gains become realized gains. Thus, if held in a taxable account, one would want a fund with low turnover. But how do taxes work in this situation? Do I directly pay taxes on the turnover profits? Are they taken out of my invested amount? Do I pay the IRS at the end of the year when the fund manager sends me my tax information? I ask because if I pay taxes when the equities within the fund are sold (at a profit), why do I have to pay capital gains taxes again when I personally sell the fund?

    Someone set me straight. I know I’m not thinking about this the right way.

    Thanks

    #221353 Reply
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 7523
    Joined: 01/09/2016

    Quick tax question,

    Index funds (or other mutual funds) are taxed as the unrealized gains become realized gains. Thus, if held in a taxable account, one would want a fund with low turnover. But how do taxes work in this situation? Do I directly pay taxes on the turnover profits? Are they taken out of my invested amount? Do I pay the IRS at the end of the year when the fund manager sends me my tax information? I ask because if I pay taxes when the equities within the fund are sold (at a profit), why do I have to pay capital gains taxes again when I personally sell the fund?

    Someone set me straight. I know I’m not thinking about this the right way.

    Thanks

    Click to expand…

    You don’t. Any gains that you pay taxes on are added to your “basis”. That means you don’t pay tax on already-taxed profits when you liquidate. Example:

    • Fund ABCDX cost                               $20,000
    • Capital gains, reinvested into ABCDX         500 (taxable)
    • New basis                                         $20,500
    • Sell ABCDX for $25,000                    25,000
    • Taxable gain                                     $   4,500 (not $5,000)

     

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #221361 Reply
    Avatar albinaire 
    Participant
    Status: Physician
    Posts: 9
    Joined: 05/02/2017

    Very good. Thank you for the clarification.

    #221385 Reply

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