Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

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A fund distributes a gain on shares held for 3 years. If a shareholder has owned the fund shares for 6 months, how is the gain taxed?

As a short-term capital gain
As a long-term capital gain
No tax due on the gain
As ordinary income

The correct answer is: As a long-term capital gain

The gain distributed by the fund is classified as a long-term capital gain because the underlying shares held by the fund were owned for more than one year. In this case, the duration for which the shareholder has owned the fund shares (6 months) does not determine the characterization of the gain; instead, it is based on the holding period of the underlying assets in the fund. Since the fund has held the shares for three years, any gain realized and distributed to the shareholders is considered long-term. For tax purposes, long-term capital gains are generally taxed at a lower rate than short-term capital gains. Thus, even though the shareholder's own holding period is shorter, they are still taxed on the distributed gain as a long-term capital gain due to the fund's longer holding period for the underlying shares.