How To Calculate Capital Gains Tax on Mutual Fund Distributions

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When you sell an investment for a profit, typically, you are required to pay capital gains tax on it. For a stock, you'd pay tax on the difference between the price you bought it for (your cost basis) and the price you sold it for. This calculation gets complicated for mutual funds, especially ones you've held for a long time, because the fund managers are buying and selling securities into the fund's portfolio. You'll have a different cost basis for your initial investment, for any additional investments, and for any purchases made through reinvested dividends.

Key Takeaways

  • Mutual funds may sell profitable investments during the year and distribute the profits to shareholders in the form of capital gains distributions.
  • Since distributions are capital gains you're required to report them on Form 1099-DIV and pay capital gains tax on them
  • Mutual fund capital gain distributions are taxed at long-term capital gains tax rates regardless of how long you own the shares within the fund
  • You can calculate your gain using one of the three IRS prescribed accounting methods but you must stick with the method you select for the particular fund
  • Additional shares purchased via dividend reinvestment have their own cost basis, which is the purchase price of the shares, and their own holding period.

How Mutual Fund Capital Gains Distributions Work

Mutual funds often sell profitable investments at certain times throughout the year. The funds then distribute the profits to shareholders in the form of capital gains distributions.

Capital gains distributions are reported on Form 1099-DIV, which shows dividends and capital gains distributions paid throughout the year. They're taxed at long-term capital gains tax rates regardless of how long you own the shares within the fund.


Long-term rates are normally reserved for assets that you've owned for longer than a year. They're more favorable than short-term rates. 

Capital gains distributions can be reported directly on Form 1040 if you have no other capital gains to report. Otherwise, they're reported on Schedule D along with your other gains and losses.

Accounting For Capital Gains Distribution

When it comes to calculating your capital gain or loss, you need to do so for each mutual fund share you sell. That is where it gets complicated, because you'll have a different cost basis and a different holding period for each share if you've invested in the fund over a period of time.

The IRS lets you choose one of three different accounting methods to calculate your gain. You might want to calculate all three methods in a trial run to determine which is the most advantageous for you.

The allowable accounting methods are:

  • Actual cost basis using specific identification
  • Actual cost basis using first-in, first-out identification
  • Average cost basis, single-category method


You must stick with that method on that mutual fund going forward when you use a particular accounting method to file your tax return. You're locked in, at least for that fund. But you can choose different accounting methods for each mutual fund you own.

Using Specific Identification

The specific identification method of accounting is the preferred method for savvy investors, but it requires ongoing attention to detail. You'll have to keep track of each lot of shares you buy and sell, and your broker must allow you to sell specific shares. This option is usually provided within a mutual fund company's cost basis tracking service.

Specific identification lets you choose which shares to sell for the greatest possible tax benefit. An investor might want to sell the most profitable shares to offset other losses, or they might want to sell the least profitable shares to minimize capital gains tax.

Using First-In, First-Out Identification

You can still use the actual-cost-basis method even if you can't specify particular shares to sell. You would keep track of your cost basis for every lot of shares you buy, and assume that the first shares sold were the first shares you bought.

Single-Category or Average Cost Method

You can calculate your average cost basis according to the price you paid for each share by using this method, including any reinvested dividends and reinvested capital gains.

The average cost basis is the total purchase price of all shares, divided by the number of shares you owned at the time. When you sell some shares, it's assumed that they're sold on a first-in, first-out basis. Your capital gain is calculated using the holding period of the oldest shares being sold, even if you're selling a mixture of long-term and short-term shares.

Reinvested Dividends and Capital Gains Distributions

Many investors reinvest dividends and capital gains distributions received from their mutual funds. Each reinvestment counts as both a cash distribution and an additional fund purchase. The dividends and capital gains distributions are included in taxable income.


The additional shares purchased in the reinvestment have their own cost basis, which is the purchase price of the shares, and their own holding period.

For example, you invested $1,000 in a non-dividend paying mutual fund. XYZ After one year, due to increase in the markets your investments in XYZ increased to $1,500. Since you invested $1,000 and got no dividends your cost basis for XYZ is $1,000. Based on that, your capital gain is $500 ($1,500-$1,000) on which you will pay capital gains tax.

Now, consider a scenario where you invested that $1,000 in a dividend paying fund ABC instead and during the year the fund paid out $500 in dividends and you reinvested that dividend money to buy more shares in ABC. Your year-end investment will still be worth $1,500 but your cost basis for ABC will increase to $1,500 because the dividend was used to purchase more shares in the fund and will be treated like an investment.

Frequently Asked Questions (FAQs)

What tax do I pay on mutual fund capital gains distributions?

When fund managers buy and sell securities in a mutual fund portfolio and generate profits, they share those profits with investors in the fund in the form of capital gains distributions. Mutual fund capital gain distribution are taxed at long-term capital gains tax rates irrespective of how long you've held the shares of the mutual fund.

How do mutual fund capital gains distributions affect cost basis?

Capital gains distributions can increase your cost basis if you reinvest them in the fund. If you purchase shares in a mutual fund worth $100 that doesn't pay dividends your cost basis will be $100 and it will be used to determine any capital gain or loss when you sell shares in the fund. If you invest $100 in a dividend paying fund and reinvest the $20 you receive as dividend in the year, you purchase of additional shares will be treated as any other investment. That means your cost basis increases to $120.

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  1. IRS. "Mutual Funds (Costs, Distributions, Etc.)"

  2. IRS. "About Schedule D (Form 1040), Capital Gains and Losses."

  3. IRS. "Publication 550, Investment Income and Expenses- Special Rules for Mutual Funds."

  4. IRS. "Topic No. 404 Dividends."

  5. Columbia Threadneedle Investments. "Cost Basis FAQs," Page 4.

  6. Vanguard. "Cost basis doesn't equal performance."

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