Mutual funds are one of the most popular investments around. With mutual funds, investors own shares in a portfolio of securities, just as they might own shares of stock in an individual company. Mutual funds generally distribute most of their income to find shareholders. Distributions may be taxable to shareholders as ordinary income or capital gains, or may consist of tax-exempt interest.

• Currently, when you sell a portion of mutual fund shares you've bought at different times and prices, you can figure your tax basis in one of four ways. We will examine 3 of these. Since a higher basis means a smaller capital gain or larger capital loss, choosing the most advantageous method can cut your tax bill.

There are alternate ways to figure your capital gains on stock sales. You might find that FIFO (First-in, First-out) is better than the more common average cost and specific shares methods. The following chart illustrates the differance.

Date Purchased	Number of Shares Bought	Total Cost
6/15/93	50 @ $40	$2,000
12/15/93	50 @ $50	$2,500
12/15/94	50 @ $10	$500
6/15/95	50 @ $30	$1,500

We will now calculate the sale of 50 shares in all 3 methods

First-in,	First-out	Specific	Shares	Average	Cost
Proceeds 50 @ $50	$2,500	Proceeds	$2,500	Proceeds	$2,500
Cost of first 50 shares purchased on 6/15/93	-$2,000	Cost of shares you tell the fund to sell 50 @ $50	-$2,500	Average cost of 50 shares - 50 @ $32.50	$1,625
L/T Gain	$500	L/T Gain	$0	L/T Gain	$875

• Reinvesting your mutual fund distributions in additional shares won't help you avoid taxes on the distributions. But the amount of the reinvested distribution does serve to increase your basis in the investment.
• Switching an investment from one fund in a family to another fund within that family is a taxable event. You could have a capital gain or loss.

The maximum tax rate on net capital gains (i.e., the excess of net long-term capital gains over net short-term capital losses) is reduced from 28 percent to 20 percent. This applies to gains after July 28, 1997, on property held more than 18 months, and on gains between May 7, 1997, and July 28, 1997, on property held more than one year. In addition, any portion of net capital gain that would otherwise be taxed at a 15 percent tax rate is taxed at 10 percent.

The maximum tax rate is further reduced to 18 percent for net capital gains on property held more than five years. This applies only for assets whose holding period begins (e.g., purchased) after December 31, 2000. In addition, the 10 percent rate otherwise applicable is reduced to 8 percent after December 31, 2000, for net capital gains on property held more than five years.

To obtain the benefits of the second reduction to 18 and 8 percent rates on net capital gains on property held for more than five years, individuals can elect to treat certain assets held on January 1, 2001, as having been sold and reacquired. Taxpayers making this election must recognize any gain (but not loss) associated with the asset.

The new rules change the taxation regarding depreciation recapture in the case of real property to which the maximum tax rate on capital gains is reduced to 20 and 10 percent (and 18 and 8 percent). Any part of a gain on the sale or exchange of such depreciable real property that represents prior depreciation is "recaptured" and taxed at a maximum tax rate of 25 percent.

The reduction in the maximum tax rate on capital gains does not apply to net capital gains on property sold after July 28, 1997, which is held more than one year but not more than 18 months, and to the sale of collectibles. The maximum tax rate on such gains remains at 28 percent.

Capital gains recognized under the installment method on payments received after May 6, 1997, also are eligible for the new 20 percent (and 10 percent) capital gains rates. Whether the installment gain qualifies for the 20 percent (and 10 percent) rates, or the 28 percent rate, will depend on the holding period of the asset that was sold, regardless of when the sale occurred.

The reduction in the maximum tax rate on net capital gains to 20 and 10 percent (as well as to 18 and 8 percent) that applies for regular tax purposes also applies to the same extent for alternative minimum tax purposes. In addition, the rules for recapture of depreciation with respect to certain real property that apply for regular tax purposes also apply for alternative minimum tax purposes, including the maximum tax rate of 25 percent on such depreciation recapture.

Here is an example of how the capital gains tax works:
Assume that Jane is in a 36% federal tax bracket and she holds a security on which she has an unrealized gain of $25K.. Depending on her holding period, the amount of tax she will pay can vary significantly.

HOLDING PERIOD	TAX RATE	TAX ON GAIN	AFTER-TAX GAIN
Less then 1 year	36%	$9K	$16K
1 Year to 18 months	28%	$7K	$18K
Over 18 months	20%	$5K	$20K

When higher-income taxpayers consider the personal exemption phaseout and the limit on itemized deductions their effective federal tax rate may climb well above the nominal top rate of 39.6%. So, it's not surprising that tax-exempt investments are so popular among these taxpayers.

Municipal bonds - Interest on these bonds is exempt from federal income tax and, generally, from state tax in the issuing state.

You can use the accompanying table to see how the yield on a tax-exempt bond investment you are considering compares to the yield on a taxable investment in your tax bracket.

Tax exempt	Tax	Rates
yield	28%	31%	36%	39.6%
4%	5.60	5.8	6.30	6.6
4.5%	6.30	6.5	7.0	7. 5
5%	6.94	7.25	7.81	8.28
5.5%	7.64	7.97	8.59	9.11
6%	8.33	8.7	9.38	9.93
6.5%	9.03	9.42	10.16	10.76
7%	9.72	10.15	10.94	11.59

For tax purposes, rental real estate investments are classified as "passive activities." Losses from passive activities generally are deducible only to the extent of income you receive from other passive activities during the year. You can carry forward excess losses to offset passive income in future years and deduct whatever is left when you sell or otherwise dispose of the rental activity. There are two special circumstances available that bypass the above general rule. The taxpayers who meet material participation qualifications become "Real Estate Professionals" and are allowed to offset passive real estate losses against ordinary income.

To qualify as a "Real Estate Professional" an individual must have more than 1/2 of their personal services (with more than 750 hours) in a trade or business connected with real estate ventures. Services performed as an employee are not considered in determining material participation unless you hold more than a 5% ownership.

This passive loss allowance is a 2 step process:

1. The taxpayer must be a "Real Estate Professional." and then
2. The taxpayer only gets relief from the passive loss provision for rental real estate activities for which they satisfy the material participation standards.

Real property trade or business would include: development, construction, acquisition, rental, management, leasing, or brokerage.

If you are renting your home or a vacation house special rules apply. Personal use of the home for more than 14 days (or 10% of the days rented, if greater) results in a residential classification. This means rental deduction cannot be more than rental income. No such limitation applies to true rental property. If your income (AGI) is less than $100K you are allowed to deduct up to $25K of rental real estate losses, but you must be an active participant in the management of the property. This exception phases out between $100K and $150K of AGI. Additional rules apply to rental property that is generally rented for 1 week (vacation) periods. The chart below outlines the rule governing vacation home rules, be sure to consult your tax advisor regarding rental property, the rules are complicated.

Days rented to tenant	Days of personal use	Rent income reported	Operating expenses deductible	Report tax loss
1 - 14	Use unlimited	No	No	No
15 - 149	Up to 14	Yes	Yes	Yes
15 - 149	15 or more	Yes	Yes - to extent of rental income	No
150 or more	0 - 10% of rental days	Yes	Yes	Yes
150 or more	10% + of rental days	Yes	Yes - to extent of rental income	No