How are capital gains taxes applied to mutual fund investors?

Mutual fund investors are taxed on capital gains in two primary scenarios: when they sell their shares of the fund and when the fund itself distributes capital gains to its investors. When an investor sells their shares, any profit realized from the sale is considered a capital gain and is subject to taxation. Additionally, mutual funds may periodically distribute their realized capital gains to investors, typically at the end of the year. When these distributions occur, investors must also report and pay taxes on them, even if they have not sold any of their shares. This dual taxation framework is essential for investors to understand, as it impacts their overall investment strategy and potential tax liabilities.

The other options do not accurately reflect how capital gains taxes are applied to mutual fund investors. It's important to note that investors are not exempt from capital gains taxes, nor are they taxed solely on dividends received or on unrealized gains yearly. The tax is specifically applied to realized gains through sales or distributions.