Do you pay taxes when you sell mutual funds? The chances are that you might have to. However, the tax implications of selling mutual funds in your regular account may be pretty different from selling a mutual fund in an IRA, especially the Roth type.
Typically, a Roth IRA allows working taxpayers to contribute to a tax-advantaged account with after-tax dollars for their retirement. You may purchase and sell a wide range of investments with funds in your Roth IRA portfolio, including shares of mutual funds. And any income generated by your investment grows tax-free, as long as the funds remain in your Roth IRA.
Read More: Form 1040: What You Need to Know
How Mutual Funds Work
A mutual fund pools funds from a number of investors, and then, invests those funds in securities that meet the mutual fund's stated investment objective. Mutual funds may invest in stocks, bonds, cash equivalents or short-term debt.
Each share of a mutual fund represents equal ownership in all of the investments within the mutual fund's portfolio. Investors purchase mutual funds because they provide the twin benefits of a diversified portfolio, which reduces risk, and professional management, improves return on investment.
Having a mutual fund in your Roth IRA provides the additional benefits of tax-free growth.
Trading and Selling Inside a Roth IRA
Trades that occur within your Roth IRA do not create a taxable event, as long as the funds remain inside the Roth account.
You may sell shares of your mutual fund for a profit without incurring a taxable capital gain, but if you sell for a loss, you will not be able to take that capital loss on your current tax return. Roth IRA capital gains may accrue if funds are taken outside of the account. You may buy and sell shares of a mutual fund within a family of funds, subject to the rules of the fund, without creating a taxable event – as long as the funds remain inside your Roth IRA account.
These are important tax implications of selling shares that you should thoroughly familiarize yourself with. You may sell shares of one mutual fund and purchase a different mutual fund in a different family of funds if your Roth account is set up that way.
All funds in your Roth IRA belong to you. You have the option of withdrawing them for any reason at any time.
If you purchased shares of a mutual fund in your Roth IRA, you may sell those shares and withdraw the entire amount that you contributed without creating a taxable event. The Internal Revenue Service refers to this as a return of principal. This type of withdrawal is tax free, because you have already paid income taxes on those funds.
Making Qualified Withdrawals
You must leave any earnings on your contributions in your Roth IRA account for at least five years to qualify for tax exemption of those funds. Once you reach 59 1/2 years of age you may begin making withdrawals of qualified earnings. The IRS refers to this type of withdrawal as a qualified withdrawal.
Qualified withdrawals are not subject to federal income taxation. You may sell any mutual fund shares held in your Roth IRA and you may withdraw the proceeds without generating any tax liability if you are at least 59 1/2 years old and the earnings have been in your Roth account for at least five years.
You may sell shares of any mutual fund you hold in your Roth IRA at any time and withdraw the proceeds. If the withdrawal does not meet the requirements as a qualified withdrawal, the earnings portion of that withdrawal will be considered non-qualified.
Non-qualified withdrawals are subject to taxation as ordinary income at your then-current tax rate. The IRS will additionally charge you a tax penalty of 10 percent of the non-qualified amount.
Reporting Requirements for Withdrawals
All of your personal income that must be reported to the IRS can be accounted for using IRS Form 1040. You can copy the capital gain distributions amount from your 1099-R tax form to line 7 of Form 1040 or 1040-SR. Alternatively, you could report that amount on Schedule D, line 13. The IRS provides extensive instructions on what to do in this regard.
Read More: Form 1040: What's Changed for Your 2020 Tax Return
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.