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About Capital Gains
What is a capital gain?
A capital gain occurs when a mutual fund manager sells a security in the portfolio that has increased in value. A capital gain is also realized when you sell a capital asset, such as a stock or bond, for more than what you paid.
What is a long-term capital gain?
It's a gain on an investment that has been held for more than one year. The maximum tax rate for a long-term capital gain is 20% plus an additional 3.8% Medicare tax for certain individuals.
What is a short-term capital gain?
It's a gain on an investment that has been held for one year or less. Short-term capital gains are taxed at the same rates as ordinary income and interest. Tax rates for short-term gains can range as high as 37% plus an additional 3.8% Medicare tax for certain individuals.
Capital Gains Distributions
Why do mutual funds distribute capital gains?
When a mutual fund generates income from its holdings or sells shares of stock and receives a capital gain, it is required by law to pay most of the income and gain, minus the fund's operating expenses, to its shareholders in the form of distributions.
Can a mutual fund pay a capital gains distribution if the fund's net asset value has fallen?
Even if a fund's share price has fallen, it is possible for the fund to have realized capital gains on stocks that it sold during the year. For example, the fund could sell a stock that has gone up significantly since the fund bought it, but whose price has recently declined. If the price when the stock is sold remains higher than what the fund paid for it, the fund has still realized a gain, which it must pass along to its shareholders as a taxable capital gain. The fund could have gains in many individual stocks, but those gains may be outweighed by losses in other stocks, resulting in a lower net asset value.
How do distributions affect the share price of a mutual fund?
On the day that a fund distributes a dividend or capital gain to shareholders, the fund's net asset value per share drops by the amount of the distribution per share. The drop in the net asset value does not reflect a loss in your overall investment value. Instead, it indicates that a portion of that value has been given to you as income or a capital gain. If you reinvest the distribution, the number of shares in your account will increase proportionally, so that the total value of your account will not be affected by the distribution.
Capital Gains Rules
What is meant by the "record date", "ex-date" and "payable date" for a distribution?
Date when the fund determines which shareholders are entitled to a distribution of dividends and/or capital gains. Shareholders "of record"–those who own shares of the fund on the record date–receive the distribution. Those who invest after the record date do not receive the distribution.
Date when the distribution of dividends and capital gains is deducted from the mutual fund's assets and set aside for payment to shareholders. On the ex-date, the fund's share price (net asset value per share) drops by the amount of the distribution.
Date on which the declared dividend or capital gain distribution is scheduled to be paid to shareholders who elected to receive cash payments.
What is the "wash sale" rule?
As applied to a mutual fund investment, a wash sale is the sale of mutual fund shares and a purchase of shares of the same mutual fund within 30 days before or after the sale. The IRS does not allow investors to use a wash sale tactic for realizing a capital loss for tax purposes. If the transaction is subject to the wash sale rule, and if there is any loss on the sale (including a difference in value because of the sales charge that was paid), it is not recognized for federal income tax purposes and generally cannot be used to offset capital gains. Investors have to wait at least 31 days before repurchasing shares in a fund sold for a loss. Be aware that this waiting period could have a negative impact on your portfolio strategy, depending on market conditions. The wash sale rule is very complicated, so you should consult your tax advisor if you are considering such a strategy.
Taxation of Capital Gains
How are distributions taxed?
If the securities were held by the fund for more than one year, the gain will be taxed at the lower capital gains tax rate and identified as long-term gains on your Form 1099-DIV, which you will receive from the fund in early February. Distributions of dividends, income, and capital gains held one year or less are taxed as ordinary income and are reported as "dividend income" on your tax return.
If I receive a capital gains distribution, but owned my share less than a year, how is it taxed?
Because the gains relate to the securities owned by the fund, a distribution of long-term gains by the fund is subject to long-term capital gains tax rates, even if you held the shares for less than a year.
If I reinvest all my fund distributions, will they still be subject to income taxes?
Yes. Distributions of dividends and capital gains in non-retirement accounts are subject to income tax regardless of whether you receive them in cash or reinvest them in additional shares.
How will I know how to report dividends and short- and long-term capital gains distributions on my tax return?
In early February, the fund will send you a Form 1099-DIV identifying all the distributions paid to you during the tax year, and it will show a breakdown between ordinary income dividends and long-term capital gain distributions.
Why is my short-term capital gain included with my ordinary income on my tax form?
Since short-term capital gains are usually taxed the same as taxable dividends, the IRS prefers that both amounts appear on the same Form 1099-DIV. A complete itemized listing of short-term capital gains and dividends can be found on your year-end account statement.
Investing involves risk. Some mutual funds have more risk than others. The investment return and principal value will fluctuate and investor's shares when sold may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. There is no guarantee a Fund's objectives will be achieved. The risks associated with each fund are explained more fully in each fund's respective prospectus. Your clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation.
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