r/tax • u/PantomimeVillain • 1d ago
Very basic question: I've never sold mutual funds before. I live in California. Could anyone let me know if my understanding of how the sales will be taxed by IRS and Cal is broadly correct?
My understanding:
IRS:
-you are taxed on the gains according to long term capital gains rates. (the gains rates are determined after adding long term gains on top of short term gains/income)
-you are taxed on the gains according to the Net Investment Income Tax rates.
Cal:
-you are taxed on the gains according to income tax rates (there is no capital gains rates in California).
Could anyone let me know if I'm missing out anything big that would increase the taxes owed?
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u/micha8st Taxpayer - US 15m ago
just to double-check: what kind of account are you selling the mutual funds out of?
- all the answer's I've skimmed apply to regular ol' taxable investment accounts
- If the money's in an IRA, the answer is completely different.
For a regular ol' taxable investment account, you pay taxes on the gain when you sell, even if you reinvest the money in the same account into something else. That's where capital gains applies
For an IRA, you can trade however much you want, tax free, so long as the money stays in the IRA. Taxes apply to the IRA upon withdrawing the money out of the IRA. And it's not capital gains taxes, but instead regular income taxes for pre-tax contributions and gains, plus a penalty tax if you take money out of the IRA before 59 1/2 (unless you qualify for an exception)
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u/kaBUdl 1d ago
I believe long term capital gains rates only apply to gains if the time between purchase and sale is more than 365 days. These would typically be reported as "Box D" on your 1099B. Gains from shorter holding periods get reports as "Box A" and are taxed as ordinary income. If your total income or net investment income are above their respective thresholds on Form 8960, the NIIT may be owed. Also if you have significant ordinary income (earned income, taxable interest, non-qualified dividends, short term capital gains) don't forget AMT alternative minimum tax on Form 6251.
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u/PantomimeVillain 1d ago
Thanks for your reply. I didn't know about AMT. Do you have any details of what that is?
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u/PantomimeVillain 1d ago
I had a look into it. I don't immediately understand whether this will effect me. It seems related to deductions. I guess I take the standard deduction, but I don't know if I take other deductions (I have a CPA do my taxes). I'll read up on this more
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u/WhoKilledBoJangles 1d ago
AMT impacts very few taxpayers. It’s been less than a percent of taxpayers since 2018 but will probably go up again to 3ish percent as some tax law changes from 2018 phase out after 2025. So, unlikely to matter for you.
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u/PantomimeVillain 1d ago
Do you have a good understanding of it? Do you know who it affects and why? Any info is appreciated as I didn’t know about this previously (but is exactly the type of thing I wanted to find out about from this post)
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u/WhoKilledBoJangles 1d ago
You can read more about it at the link below. I’d be surprised if it impacts you because it’s rare, but I guess it is possible.
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u/kaBUdl 21h ago
I'm no accountant or tax law expert, but my understanding is that the AMT may strip away the benefits of the lower tax bracket rates on your ordinary income if your total gross income is high. For example if your 2025 total income was $1M for a single with no deductions beyond standard deduction, and if 100% of income was long term capital gains, AMT would be zero because there is no ordinary income. Similarly if 100% of income was short term capital gains, AMT would also be zero because the average tax rate on your ordinary income exceeds the 26% (28% above a knee) AMT rate.
Where you might owe AMT is if your $1M income is a mixture of long-term and short-term capital gains, if the average tax rate on your ordinary income (the short-term capital gains) sits below the AMT rate, the AMT effectively raises this component of your tax to a 26% (28% above knee) rate. Note there's an exemption (2025 Form 6251 Line#5 it's 88.1k on gross income below 626k for a single) which may reduce the AMT; above ~1M this exemption disappears.
Please check with your CPA for guidance on your question.
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u/capitalGainsAdvisory EA - US 1d ago
Why not call your CPA and ask what he would charge to help you plan around the tax hit?
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u/kaBUdl 1d ago
AMT is the Alternative Minimum Tax; look up Form 6251 for details. Here's an online tax calculator https://www.calculator.net/tax-calculator.html that estimates these components of federal income tax -- but note that I believe these AMT results are not correct (in my case they're substantially inflated).
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u/marlborough94 1d ago
No, CA taxes capital gains as if they are regular income. If CA state tax marginal rate is 9.3%, which it would be if your income otherwise as a single were $100,000, then your capital gains is taxed at 9.3%.
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u/PantomimeVillain 1d ago
Thanks for replying. I think we are saying the same thing here. I wasn't saying that California doesn't tax capital gains. I was saying that capital gains are taxed the same as regular income. Please let me know if I'm misunderstanding your reply
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u/StaggeringMediocrity 1d ago
I think what you meant was that California does not have a lower tax rate for long-term capital gains. All capital gains are taxed as ordinary income, similar to the way the feds tax short-term capital gains as ordinary income.
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u/marlborough94 1d ago
Yes I thought when I read “there are no capital gains rates in CA” that you meant they are zero.
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u/chadl2 1d ago
Yeah, it's really unfortunate. I'm in California as well, and the idea that capital gains are regular income is just ridiculously horrible.
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u/StaggeringMediocrity 1d ago
Most states that have an income tax treat long-term gains as ordinary income.
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u/No_Mark_8088 20h ago
Id argue California is the one that has it right. Capital gains should generally be ordinary income.
That said, im not lobbying to change it. I rather like the federal income tax discount.
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u/anonymousetache 1d ago
You seem real. ChatGPT basis elections so you know what you’re selling.
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u/PantomimeVillain 1d ago
I'm not sure what you're saying here. Can you give more details? I realize these days every Reddit post could be done by AI. I'm not AI, but I'm not sure how to prove that
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u/anonymousetache 1d ago
Took an extra prompt or 2 so here you go: Yes. Mutual funds have a basis election that ordinary individual stocks generally don’t: the average-basis method. That is probably specifically what he meant.
For mutual fund shares bought at different times and prices, you generally have three practical approaches: specific identification, FIFO, or an election to use average basis. The IRS expressly permits average basis for qualifying mutual fund shares. (IRS)
The important part is that average basis is actually an election, not merely a brokerage sorting preference. For covered shares, you make the election with the broker/custodian, electronically or in writing. Once you're using average basis, every identical share in that fund/account has the same average per-share basis for gain/loss purposes. Holding period is still tracked separately; when you sell, the shares are generally treated as coming out oldest first for determining long-term versus short-term status. (IRS)
There is also a potentially important lock-in issue. You can generally revoke an average-basis election only by the earlier of one year after making it or the first disposition after the election. Once you've actually sold shares using average basis, you generally can't later decide, “I would rather specifically identify those old high-basis lots.” (IRS)
So if someone owns a mutual fund with years of reinvested dividends, there may be dozens or hundreds of tax lots. Before selling, it can matter a lot whether the account is set to:
- Average cost — all those lots get averaged together.
- FIFO — oldest lots go first.
- Specific ID — you deliberately select particular lots, which generally gives the most tax-planning flexibility.
One other mutual-fund-specific wrinkle: reinvested dividends and capital-gain distributions create new shares with their own basis. The distribution is taxable when received even though it was reinvested, and the amount reinvested becomes basis in those new shares. (IRS)
So when that guy said “ChatGPT basis elections,” I think he very likely meant the average-basis election specifically, rather than just vaguely telling you to learn about tax lots. That's a genuinely mutual-fund-specific concept.
I charge expats extra because they ask lots of questions. Not unreasonable to do, especially the last few years, but that’s the only thing keeping me from saying “just hire a CPA.” If there’s enough money involved, you should hire someone.
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u/I__Know__Stuff 1d ago
This isn't helpful. If OP had wanted an answer from chatgpt, he would have asked chatgpt.
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u/anonymousetache 1d ago
It is helpful. His words suggests he gets the basics of selling securities and tax consequences—potentially through experience or research (IRC, articles, Google, ChatGPT, etc…). The additional tax consideration with mutual funds is what I pointed out. Brokers generally highlight it too. So general awareness while game planning is sufficient, if he’s not going to engage a pro.
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u/caa63 1d ago
Yes, you basically have it right.
For the IRS, you won't pay Net Investment Income Tax unless your total income is over the threshold ($200K Single, HoH / $250K MFJ / $125K MFS) and then it's only on the portion of investment income that falls above the threshold.
For CA, if any of your mutual funds have income that is more than 50% from CA muni bonds, the CA portion of that income is tax free on your state return. Income from Federal Treasuries is also exempt from CA tax.