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Maybe it has always been this way, or maybe the tax laws changed, but when I got my 1099 from my broker I was a bit surprised to see them reporting over $3000 in capital gains income (line 2a on 1099-DIV) despite the fact that I held those funds for the entire year and didn't sell any of it.

My understanding is that capital gains are realized when you sell an investment and only dividend income is taxable while you are still holding it. What am I missing here?

If it matters, the funds were PRSVX, VIPSX, and WMFAX.

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A mutual fund itself generally isn’t taxed on its income or gains. To avoid taxes, each year a mutual fund has to pay out and pass through to its shareholders most of its net interest, dividends, and capital gains. You as the shareholder are taxed on your share of these items.

If you review the annual reports for your funds, you will see that part of each years distribution is net investment income, primarily interest and dividends it receives, and the remainder is net realized gain. Here is an example: http://quote.morningstar.com/fund-filing/Semi-Annual-Report/2015/6/30/t.aspx?t=&ft=N-CSRS&d=1ea29b5b7934db78752035b54bb7c04f

In the example linked, for the year ended 12/31/2014, your fund distributed $3.49 per share of which $3.15 was net realized gain.

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  • This is why people sometimes say ETF's have tax advantages over mutual funds. With an ETF you only have a taxable capital gain when you actually sell (though you do have to pay taxes on the dividends).
    – farnsy
    Feb 18, 2016 at 4:56

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