Mutual funds provide investors with several benefits, including instant diversification, professional management and precise recordkeeping. Part of the recordkeeping process is to inform you of your capital gains so that you can report them accurately to the Internal Revenue Service. Your particular situation dictates whether you need to use Schedule D, Capital Gains and Losses, to report your capital gains from mutual funds.
TL;DR (Too Long; Didn't Read)
You will use Schedule D to report a variety of capital gains accrued throughout the year. However, there are a variety of situations where you are not required to use Schedule D, such as if you have sustained no capital losses.
Capital Gains Distributions
You can earn capital gains from a mutual fund through distributions and share trading. Capital gains distributions arise from profitable trades your fund manager makes. Mutual funds frequently buy and sell securities within their portfolios. A capital gains distribution allocates portfolio-trading gains to mutual fund shareholders. Mutual funds report capital gain distributions on Internal Revenue Service Form 1099-DIV. You treat all such capital gains as long-term and thus eligible for lower taxes. In 2017, the tax rates on long-term capital gains range from zero to 20 percent, depending on your income. In 2018, the range of rates will stay the same, though the brackets will change slightly. Short-term gains, which come from investments you’ve held for a year or less, are ordinary income, taxed at your marginal rate.
Reporting Various Distributions
You do not have to use Schedule D if your capital gains distributions meet certain requirements: you have no capital losses, your only capital gains stem from distributions and you have no unrecaptured section 1250 real estate gains, section 1202 gains on qualified small business stock or 28-percent gains on collectibles. In this situation, you need only fill out Form 1040. The form has a Qualified Dividends and Capital Gain Worksheet you can use to figure your tax. If you don’t meet the requirements, you must use Schedule D, but can avoid Form 8949 if your capital gains and losses only arise from distributions, a capital loss carryover and certain other sources such as partnerships, estate, trusts, S corporations and installment sales.
Undistributed Capital Gains
Mutual funds normally distribute all of their capital gains to shareholders. By doing so, they avoid income tax – the tax obligation passes through to shareholders. A mutual fund may decide to retain some of its capital gains and pay the taxes on them. A fund issues you Form 2439 to report undistributed capital gains. Attach a copy of the form to Schedule D and report the tax paid by the mutual fund on Form 1040. Your fund will tell you how much of the undistributed capital gains are unrecaptured section 1250 gains and section 1202 gains. Use this information to fill out the appropriate Schedule D worksheets. You also must report section 1202 gains on Part II of Form 8949.
You create capital gains when you sell mutual fund shares, and the proceeds exceed the purchase cost. The fund will send you Form 1099-B specifying the amount of short- and long-term capital gains you earned from selling shares. If you sell shares purchased at different times, you can identify which shares to sell or you can let the fund company sell shares on a first-in, first-out basis. Use the information from Form 1099-B to fill out Form 8949 and summarize the results on Schedule D. If some of your capital gains come from passive activities or rentals, you might also have to fill out Form 8582.
- Internal Revenue Service Publication 550: Investment Income and Expenses
- Oblivious Investor: Dividend and Long-Term Capital Gain Tax Rates for 2013
- Internal Revenue Service Form 8949: Sales and Other Dispositions of Capital Assets
- IRS: Instructions for Schedule D
- Tax Policy Center: How Are Capital Gains Taxed
- The Motley Fool: Long-Term Capital Gains Tax Rates in 2017
- The Motley Fool: Your Guide to Capital Gains Taxes in 2018