In this article, we’ll take a look at capital gains distributions from mutual funds, why they’re made and how they impact you as an investor.

Most mutual funds buy and sell securities within their portfolios throughout the year. If those sales result in a net realized capital gain, they must be passed along to shareholders as a taxable fund distribution.

Any mutual fund can make a capital gains distribution, although stock funds tend to make them more often than others. Funds that do a lot of trading are more apt to make a capital gains distribution, while index funds, since they usually do little trading throughout the year, tend to make capital gains distributions infrequently. Capital gains distributions typically occur just once at the end of the year, although funds may occasionally make a second “spillover” distribution the following year. Capital gains distributions are taxable in the year they occur.

Tax-managed mutual funds specialize in managing trading activity so as to not make capital gains distributions. The Vanguard Tax-Managed Capital Appreciation Fund (VTCLX), for example, has never made a capital gains distribution since its inception in 2001.

For more information on the taxation of mutual funds, take a look at our article on How Mutual Funds Are Taxed.

Capital gains are broken down based on how long the fund has held the security. If it’s been held for less than one year, distributions are categorized as a short-term gain. If the securities have been held for longer than one year, distributions are tagged as long-term gains.

This is an important distinction for shareholders because short-term and long-term gains are taxed at different rates. Short-term capital gains distributions are taxed at the shareholder’s ordinary income tax rate. Depending upon income level and filing status, this rate can range from 10% up to 39.6%. Long-term gains get taxed at the long-term capital gains rate. Taxpayers in the two lowest brackets, 10% and 15%, pay no long-term gains tax. Most others pay a 15% capital gains tax with the exception of those in the highest tax bracket, who pay a 20% tax on long-term gains.

In addition to mutual funds, ETFs provide distributions – check out our article on ETF Distributions and Capital Gains.

Mutual funds that make capital gains distributions are required to provide a 1099-DIV form to shareholders. The two columns you’ll need to pay attention to on the 1099-DIV are the ones for total ordinary dividends and total capital gains distributions.

Short-term capital gains distributions are lumped together with any dividend and income distributions and appear under the total ordinary dividends column. Long-term capital gains distributions appear under the total capital gains distributions column and may need to be reported on the IRS’s Schedule D form when filing taxes.

With our Dividend Reinvestment Calculator, find out how much you can make investing in dividend-paying stocks.

While any mutual fund can make a capital gains distribution, it’s normally just stock funds that do so. Here are five funds that have made capital gains distributions in 2016. Click on the ticker symbol within the table for more information on the capital gains distribution analysis offered for each fund.

Tax considerations are an incredibly important part of mutual fund investing. Deciding which fund to invest in, what type of account to hold it in and how long to hang on to it can mean saving hundreds, if not thousands, of dollars come tax time. Understanding capital gains and how they’re taxed goes a long way towards accomplishing that goal.

To learn more about how mutual fund distributions are taxed, check out the Taxation section on our website.