I’m curious about state bond funds like the Vanguard Massachusetts Tax-Exempt Fund (VMATX).
I know that the underlying assets are state bonds. I know there are ways to directly buy these bonds. And, if I understand correctly, if you directly buy them, then the yield is not subject to state or federal income tax. The Product Summary on Vanguard also says income is “exempt from both federal and [state] personal income taxes.”
My question: what happens when you package a bunch of these bonds into a fund? Are the gains on these bond funds also tax-exempt?
For example, say I deposit $10,000, some time later it’s worth $12,000, and I withdraw the $12,000. Do I still pay taxes on the $2,000 gain?