Investing Assets & Markets Mutual Funds What Are Mutual Fund Capital Gains Distributions? Mutual Funds Capital Gains Distributions Explained By Lee McGowan Lee McGowan Lee McGowan is a certified financial planner, a certified financial analyst, and a fee-only financial advisor. He is the president and senior wealth advisor at Monument Group Wealth Advisors. His analysis and commentary have been published in The Wall Street Journal, Investor's Business Daily, and The Journal of Financial Planning (where he also served on the Advisory Board). learn about our editorial policies Updated on March 31, 2022 Reviewed by JeFreda R. Brown Reviewed by JeFreda R. Brown Facebook Instagram Twitter JeFreda R. Brown is a financial consultant, Certified Financial Education Instructor, and researcher who has assisted thousands of clients over a more than two-decade career. She is the CEO of Xaris Financial Enterprises and a course facilitator for Cornell University. learn about our financial review board In This Article View All In This Article Definition and Example Mutual Fund Capital Gains Distributions How Does a Mutual Fund Capital Gains Distribution Work? What It Means for Individual Investors Frequently Asked Questions (FAQs) Photo: Westend61 / Getty Images Definition Mutual funds capital gains distributions are net capital gains from the sale of shares of securities held within the fund. These distributions are taxable to the fund shareholders unless the fund is owned in a tax-deferred account, such as an IRA or 401(k). Definition and Example Mutual Fund Capital Gains Distributions Mutual fund shareholders face the possibility of receiving capital gains distributions from their mutual funds each year around November or December. These distributions are the result of the fund's managers selling shares of one or more of the fund's holdings during the tax year. Capital gains can occur if the fund manager decides to sell stock due to the changing outlook, or even if the fund must simply raise cash for shareholder redemptions. The fund must distribute at least 95% of its gains and resulting taxes to shareholders if the stock is trading higher than when the fund manager initially purchased it. These distributions are paid to you or credited to your mutual fund account, so they are considered your income. You do not have to sell shares of the mutual fund in order to have realized a capital gain. Note For stocks or bonds, a distribution occurs when you receive a payment of a dividend, interest, or principal from the issuer of the security. How Does a Mutual Fund Capital Gains Distribution Work? Suppose XYZ Mutual Fund purchased 100,000 shares of a company 20 years ago for $1. The fund sells the shares today for $50, which results in a long-term capital gain of $49 per share. The fund must distribute the gain to current shareholders, who must report the gain on their personal tax returns. Note It might seem like a good thing to receive a capital gains distribution, but there's actually no positive economic value to the distribution. Suppose you own 1,000 shares of XYZ Mutual Fund, and you reinvest all capital gains and dividends. Your investment in the fund equals $10,000 if the fund has a net asset value (NAV) of $10 per share. The gain upon the sale of stock is 10% of the fund's total net asset value (NAV), or $1 per share, if the fund distributes long-term capital gains. Shareholders will receive $1 for each share they own on the record date, and the NAV of the fund will be reduced by $1 on the ex-dividend date. Your account will receive $1,000 as a result. You'll still own $10,000 of the fund, assuming that there's no change in market value. What It Means for Individual Investors Capital gains distributions result in a tax bill if you own mutual funds in a taxable account, but they don't impact retirement accounts. The reinvestment of the gains is added to your cost basis, which lowers your taxable gain when the fund is eventually sold. Note You might want to focus on low-turnover funds if you own mutual funds in a taxable account. These include index funds, tax-efficient mutual funds, and even some actively managed funds. Visit your fund company's website at the start of in October of each year to find out whether and when there will be capital gains distributions. Weigh the pros and cons of owning the fund if you expect the distributions to be large. You might want to sell the fund to avoid the distribution and the tax bill that will come with it. Keep in mind, though, that you'll run afoul of the Internal Revenue Service (IRS) wash sale rules if you buy the fund again within 30 days, either in your taxable account or in your IRA. A wash sale happens when you sell or trade an asset at a loss and then, within 30 days either after or before the sale, you do the following: Buy substantially identical securities;Acquire substantially identical securities in a fully taxable trade; and/orAcquire a contract or option to buy substantially identical securities If your trades fall under the wash sale rule, you won't be able to deduct the losses on your tax return. To prevent this result, think carefully before selling shares in your mutual fund. You want to be sure that avoiding the tax burden from capital gains distributions is worth disposing of your shares. Key Takeaways Mutual funds often sell shares of the fund’s holdings late in the year due to changes in the market or to raise cash.You can realize a long- or short-term capital gain as a result, causing taxes to be due.You can sell a fund to avoid distributions if you understand the rules.Distributions from funds held in a tax-advantaged account, such as a retirement plan, are not taxable. Frequently Asked Questions (FAQs) Where do mutual fund capital gains go? Mutual fund capital gains are usually reinvested into your account for you. How can I offset capital gains mutual fund distributions to lower my income taxes? Owning mutual funds through a retirement account will lower your income tax burden. You can also use tax-loss harvesting to offset capital gains with capital losses, which can lower or even eliminate your capital gains tax burden. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Internal Revenue Service. "Mutual Funds (Costs, Distributions, etc.)." U.S. Securities and Exchange Commission. "Net Asset Value." U.S. Securities and Exchange Commission. "Wash Sales." Internal Revenue Service. "Topic No. 409 Capital Gains and Losses."