Automatic reinvestment is a great strategy but is still subjected to being taxed.
Many mutual funds give you the choice of automatically reinvesting dividends and capital gain allocations back into the fund. This is an excellent option to acquire new shares and build your investments.
The majority of shareholders indeed take advantage of this mechanism. However, it should be understood that this reinvestment is still subjected to taxation as any new investment would be. Some investors wrongly assume that because they did not pocket the dividend or gain that it won’t be considered taxable income. Dividends reinvested are treated as cash and thus you are taxed accordingly.
Likewise, capital gain allocations reinvested are taxed as long-term capital gain.
If you choose to reinvest, combine the total reinvested to the cost basis of your account. In other words, the amount for which you bought your shares. The cost basis of your newly purchased shares via automatic reinvesting can be seen on the account statements you receive from your fund.
You’ll want to make sure you keep this information as it’s critical when you sell shares.