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Tax Papers on a Table

Taxation

Mutual Fund Distributions: How Return of Capital Distributions Are Taxed

David Dierking Apr 18, 2017




What Is a Return of Capital Distribution?


A return of capital distribution reduces the tax basis of the investment and can impact capital gains taxes when the investors finally sell their shares.

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


Tax Implications of Return of Capital Distributions


Consider an investor that purchases 100 shares of XYZ Fund for $10 per share. One year later, the fund makes a $1-per-share return of capital distribution. The cost basis for the investment then drops to $9 per share. If the investor goes on to sell his shares for $11 per share, the trade will generate a $2-per-share capital gain. Since the cost basis of the investment is reduced, returns of capital can result in larger capital gains or smaller capital losses when a sale of shares is made. They may also improve the tax efficiency of the investment as long-term gains are taxed at the more advantageous capital gains rate if held for more than one year.

At tax time, shareholders who receive a return of capital distribution will receive a 1099-DIV form from the fund’s provider. Return of capital shows up under the “Non-Dividend Distributions” column on the form.

In addition to mutual funds, ETFs also provide distributions. Read about it in our article on ETF Distributions and Capital Gains.


Why Are Return of Capital Distributions Made?


Return of capital may also occur in managed payout funds. These funds look to make fixed monthly distributions to shareholders. If the fund is unable to generate enough income to make the full monthly payment, a return of capital distribution may be made to make up any shortfall.

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


Funds That Recently Made Return of Capital Distributions



The Bottom Line


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

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