Ok - I am trying to wrap my brain around this and am humbly asking for help.
Please be kind.
I buy 10 shares of a mutual fund at $50/share = $500 investment. At the end of the year, the fund distributes $50 in capital gains. The following year, when the share price reaches $75/share, I sell receiving proceeds of $750.
Which is correct:
1. I pay tax on $50 in capital gains in the first year and $200 in cap gains in the second ($750-$500-$50).
2. I pay tax on $50 in capital gains in the first year and $250 in capital gains in the second year (the prior year's capital gains are not counted).
I understand how this works when selling individual shares of stock, but am having problems understanding how it works for mutual funds. Up to now, all my mutual funds have been held in retirement accounts, but now I've saved enough that I want to start investing outside the tax shelter of retirement accounts.