What is Capital Gains Distribution?

Capital gains distribution refers to an investment payout distributed to investors by the fund's manager. Capital gains are made of profits realized when securities or stocks in a fund or investment are sold by the manager. Capital gains can also be realized from interest earned by a fund or the fund's returns minus its operating expenses. According to tax and investment law in the United States, fund managers are mandated to pay a percentage of an investment's income to investors as capital gains.

How Does Capital Gains Distribution Work?

Capital gains distributions are taxable, these are payment from a fund or investment shared amongst shareholders. The most common sources of capital gains are profits realized over the sale of stocks and securities and interests (returns) realized by an investment. Capital gains are distributed to investors based on the number of stock holdings they have in the investment. This means investor A might get more distribution than investor B if the former has a greater holding. Capital gains distributions are done by fund managers and are subjected to capital gains tax by the Internal Revenue Service (IRS). 

Capital Gains Distribution Instance 

The same way capital gains distributions is mandatory for a fund manager is the same way shareholders are mandated to pay capital gains tax. Capital gains are often distributed using the number of holdings an investor has in a fund. Also, the distribution is based on how long the fund held the holdings that were eventually sold. The long-term capital gains and are short-term capital gains are also considered in the distribution of capital gains. Generally, capital gains distributions are done at that period of the year then the investment is no longer yielding returns and or less profitable. The length of time at which an investor holds or owns stocks in a fund is not considered in capital gains tax, essentially, the fund itself and how long it holds the stocks sold is important. Hence, whether an investor holds stocks in a fund for only three months, such an investor is still required to pay long-term and short-term capital gains tax using the duration the fund held the stocks.

Capital Gains Distributions and Net Asset Value

A capital gains distribution has an effect on the Net Asset Value (NAV) of a mutual fund. The number of profits distributed to shareholders as capital gains are deducted from the NAV of a fund. For instance, if the NAV of a fund is $100 and $20 was shared to investors as capital gains, this would be deducted from the NAV giving an $80 remainder.