Mutual funds can be relatively easy investments to buy and sell, but when it comes to the taxman, it seems nothing is ever simple. For a taxable account, each time you sell shares in a mutual fund, whether by redeeming, exchanging, or writing a check, you create a taxable event. That means, come tax time, you'll need to report any gain or loss from these transactions.

Even though many funds and brokers provide year-end statements of your transactions, it's best to keep all confirmation statements which show your mutual fund buys and sells. That way, you can verify information from the original documents. For each purchase, sale, or exchange, you need to know:

  • The date
  • The number of shares
  • The price per share
  • The dollar amount
  • Any fees or commissions

Reinvested dividends or capital gains distributions are also considered mutual fund share purchases, and you should keep records of these as well.

Research before investing
As the end of the year approaches, many funds will provide an indication of the size of their year-end taxable payouts. If the payout will be large, it might be small-f foolish to invest and take the tax hit. For many funds, history tends to repeat itself; beware of funds that have experienced high taxable payouts in the past, since they stand a good chance of a future payout. Also, take a look at the fund's annual and semiannual reports to see whether it has any unrealized or undistributed line items. If these categories are large, then the fund may soon make a payout to investors, further increasing their tax liability.

Tax-efficient investing
An overall portfolio strategy would be to put income securities into your retirement fund and growth equities in your taxable account. Funds that frequently make distributions are generally more suitable for a tax-deferred account, such as an IRA or 401(k). If you want fixed income for a taxable account, consider buying municipal bond funds instead of government security funds, since munis can be exempt from state, county, and even city taxes.

Many mutual fund companies offer tax-managed funds that use various strategies to minimize distributions. On the low-fee side, Vanguard offers the Tax Managed Capital Appreciation Fund (FUND: VMCAX), which has a return so far this year of just less than 9.6%. The fund has a 0.14% expense ratio and a $10,000 minimum, along with a 1% redemption fee. American Century Capital Value (ACTIX) has a higher 1.10% expense ratio, but a lower $2,500 minimum, and a return so far this year of slightly more than 13.53%.

For the most part, tax-managed funds should avoid short-term gains and stocks that pay dividends. Also look for funds with low turnover rates. The less a fund trades, the lower your tax hit from that fund will be. Index funds are often low-turnover funds, since many don't realize capital gains as often as actively managed funds.

Even though there are many funds with "tax-managed" or something similar in their names, a fund doesn't have to carry that moniker in order to be tax-friendly to investors. ETFs can be very effective for delaying taxes, especially if you're a long-term investor. Their tax hit will most likely occur only when you sell the fund.

Don't get so carried away in the quest to avoid paying taxes that you skip good returns solely for a reduced tax bill. It may seem attractive to eliminate taxes altogether, but for most investors, taxes are inevitable. Manage them Foolishly, not foolishly. Don't just try to lower your tax bill; find a solid, tax-efficient investment strategy as well.

For more helpful tax tips, be sure to visit our user-friendly Tax Center.

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Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She does not own shares in any of the funds or companies mentioned in this article. The Motley Fool has a disclosure policy.