The mutual fund manager buys and sells stocks and bonds continually, in response both to changing market conditions and to the flow of money into or out of the fund. When the manager sells a stock or bond at a higher price than he paid for it, the difference is a kind of profit known as a capital gain. As with dividends, the capital gains received by a mutual fund are distributed to owners of the fund, usually in the form of additional fund shares.
When tax time arrives, the Internal Revenue Service calls for varying treatments for the different kinds of profit you make when you own a mutual fund.
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