Capital Gains Distribution

What is a 'Capital Gains Distribution'

A capital gains distribution is a payment to shareholders that is prompted by a fund manager's liquidation of underlying stocks and securities in a mutual fund, or derived from dividend and interest earned by the fund's holdings minus the fund's operating expenses. Capital gains distributions must be made by a mutual fund manager because tax law dictates that substantial portion of investment income and capital gains must be paid to investors.

BREAKING DOWN 'Capital Gains Distribution'

Capital gains distributions are taxed at capital gains rates to the person receiving the distribution. Holders of mutual fund shares are required to pay capital gains tax on any capital gains distributions made by the funds they own. Before 1986, all mutual fund shareholders were charged long-term capital gains on distributions, regardless of how long they held the funds. With the passing of the 1986 Tax Reform Act, shareholders now pay long- or short-term capital gains tax based on the time they've owned the fund.

Capital Gains Distribution Example

Assume that an investor owns 2,000 shares of a mutual fund that has five million total shares outstanding. During the year, the mutual fund realized $15 million in total capital gains from the sale of stock positions in its portfolio. Of that total gain, 80% are long-term capital gains and 20% are short-term capital gains. In this scenario, the fund would distribute the following amounts to this particular investor:

Long-term capital gain distribution to investor = $15,000,000 x 80% x (2,000 / 5,000,000) = $4,800

Short-term capital gain distribution to investor = $15,000,000 x 20% x (2,000 / 5,000,000) = $1,200

If the investor was in the highest marginal tax bracket, 39.6%, he would then be required to pay 20% tax on the long-term distribution and 39.6% tax on the short-term distribution:

Long-term capital gains tax due = $4,800 x 20% = $960

Short-term capital gains tax due = $1,200 x 39.6% = $475.20

Regardless how long the investor owned the fund, the distributions are taxed based on how long the fund itself held the sold holdings. For example, if the investor in the example above only held the fund two months, he would not pay short-term capital gains tax on all of the distribution, rather he would pay the long-term and short-term taxes based on how long the fund held the stocks.

Capital gains distributions may occur even if a fund's price has dropped during the year. For example, a fund may have sold some stocks that appreciated in price since the fund purchased them, but these gains may be outweighed by a larger group of stocks that experienced recent price declines. The overall net effect can be a lower net asset value.

RELATED TERMS
  1. Capital Gain

    1. An increase in the value of a capital asset (investment or ...
  2. Capital Gains Treatment

    The specific taxes assessed on investment capital gains as determined ...
  3. Capital Gains Tax

    A type of tax levied on capital gains incurred by individuals ...
  4. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected ...
  5. Long-Term Capital Gain Or Loss

    A gain or loss from a qualifying investment owned for longer ...
  6. Distribution

    1. When trading volume is higher than that of the previous day ...
Related Articles
  1. Financial Advisor

    How to Navigate Taxable Mutual Fund Distributions

    It's almost time for year-end capital gains distributions for mutual funds. Here's how to monitor them and minimize their tax impact.
  2. ETFs & Mutual Funds

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  3. ETFs & Mutual Funds

    The Basics of Income Tax on Mutual Funds

    Learn about the basics of income tax on mutual funds, including what types of income may be subject to the capital gains tax rate.
  4. ETFs & Mutual Funds

    How Mutual Funds Are Taxed in the U.S.

    A look at how mutual funds are taxed and how investors can be more tax efficient.
  5. ETFs & Mutual Funds

    Seek Out Past Losses To Uncover Future Gains

    Tax loss carry-forwards can help reduce the tax burden of owning a profitable fund.
  6. Financial Advisor

    After Poor Performance, Now a Mutual Fund Tax Hit?

    If the performance of mutual funds in 2014 wasn't bad enough, here comes a tax hit from liquidations.
  7. Personal Finance

    What You Need To Know About Capital Gains And Taxes

    Find out how your profits are taxed and what to consider when making investment decisions.
  8. Investing

    Advising FAs: Explaining Mutual Funds to a Client

    More than 80 million people, or half of the households in America, invest in mutual funds. No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
  9. ETFs & Mutual Funds

    Mutual Funds

    What mutual funds are: Professionally managed pools of stocks, bonds and/or other instruments that are divided into shares and sold to investors. Pros: Diversification; liquidity; simplicity; ...
  10. ETFs & Mutual Funds

    Understanding Mutual Fund Returns

    By Richard Loth (Contact | Biography)The return on any investment, measured over a given period of time, is simply the sum of its capital appreciation and any income generated divided by the ...
RELATED FAQS
  1. Do I have to claim the capital gain distribution on my federal return?

    Aren't capital gains only payable when you sell the underlying security? I'm getting a 1099-Div form from my mutual fund ... Read Answer >>
  2. How often do mutual funds pay capital gains?

    Find out how often mutual funds distribute capital gains income, including the basics of how mutual funds work and why frequent ... Read Answer >>
  3. What is the difference between income tax and capital gains tax?

  4. How are capital gains calculated when using an online brokerage account?

    Are capital gains calculated annually or on every trade? How can selling a stock at a loss save me money on taxes? Also, ... Read Answer >>
  5. Do mutual fund companies pay taxes?

    Learn how mutual funds are incorporated as regulated investment companies and are exempt from paying taxes under certain ... Read Answer >>
  6. Do mutual funds pay interest?

    Find out how and why some mutual funds pay interest, and which types of funds make regular dividend distributions to shareholders ... Read Answer >>
Hot Definitions
  1. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  2. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  3. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  4. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  5. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  6. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
Trading Center