CAPITAL GAINS FROM REDEMPTION OF SHARES

A capital gain is concerned with the change in the net asset value (value per share) of a mutual fund.

You earn a capital gain from your mutual fund when you redeem fund shares that have risen in value. More precisely, a share has a capital gain only when it is sold for more than it was purchased for. If you buy shares of a fund at 10 dollars each, and you sell them for 14 dollars a month later, you have made a capital gain of 4 dollars per share. It is important to remember that you realize a capital gain only when you sell shares. While they are still in your hands, your profits are only on paper. Therefore, you are taxed on them only when they are sold.

Capital losses are the losses that result when you sell shares that have fallen in value. Obviously, they are not income. Capital gains are either short-term or long-term. Short-term capital gains are gains on shares that have been held one year or less. Long-term gains are those that have been held longer than one year.

The difference is crucial, because long-term capital gains are taxed at a lower rate than your regular income. Long-term capital gains are taxed at 15 percent for taxpayers in the 25 percent and higher brackets. For those in the 10 and 15 percent brackets, long-term capital gains are taxed at 5 percent and then at zero percent in 2008. Be aware, however, that this tax benefit only applies to capital gains transactions after May 5, 2003. In 2009, the lower rates "sunset" or expire, and the tax on capital gains will revert to the prior 10 percent and 20 percent rates.

What does all of this add up to? Next, we will sum up dividends and capital gains.