Question

An investor buys 100 shares in a mutual fund on January 1, 2012, for $60 each. The fund earns dividends of $2.50 and $4 per share during 2012 and 2013. These are reinvested in the fund. Its realized capital gains in 2012 and 2013 are $4 per share and $5 per share, respectively. The investor sells the shares in the fund during 2014 for $70 per share. Explain how the investor is taxed.

Answer 1

Answer:

Value of the investment at the beginning of year 2012 = $60 x 100 = $6,000

Dividends earned:

Dividends earned (end of year 2012) = 2.5 x 100 = $250

The investor should report this amount with the tax annual returns and this amount was reinvested back into mutual fund immediately, So it is treated as the investor paid in cash.

Capital Gain

Capital gain = 4 x 100 = $400

This amount is taxable treated as short-term capital gain and it is taxed at ordinary income tax rate which is relatively high.

Dividends payable:

Total investment = $250+$600 = $850

This is a new adjusted cost basis (The total purchase amount, add any commissions add all amount reinvested, (less) the returns of capital)

Dividends 2013:

The amount will be added by the investor his 2013 taxable amount and be taxed at marginal ax rate.

The reinvesting amount, the cost basis for the mutual fund shares is adjusted again.

Capital gain: 2013 ($5 per share)

The amount is considered to be long-term capital gain and taxed a long term capital gain rate which is relatively low rate

Sale of shares:

The market price of the shares is calculated, the difference between sale of shares and selling price ($70) is treated as a capital gain and taxed using long-term capital gain rate (it has been held for more than one year so it is considered as long-term capital gain)