Capital gains FAQ
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Q: What is a capital gain?
A: When you sell a capital asset — such as a stock or a bond — for more than you paid for it, you make a profit, or experience a capital gain. So if you buy a stock for $100 and later sell it for $120, your capital gain is $20. When a fund sells securities at a profit, the sale also creates a capital gain. Two types of capital gains are realized by our funds — short-term and long-term. Net short-term capital gains are distributed to shareholders as income dividends and are taxed at ordinary income tax rates. Long-term capital gain distributions are taxed at a maximum rate of 15%.
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Q: Why do mutual funds pay capital gain distributions?
A: When mutual funds sell securities, they typically realize gains or losses. If gains exceed losses, funds are required by law to distribute substantially all of their net gains to their shareholders before the end of the calendar year. These distributions, which typically occur once or twice a year, are made primarily for tax reasons.
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Q: How can mutual funds pay capital gain distributions when the market is down?
A: When the value of a fund holding increases, the fund has an unrealized gain until the security is sold. Once this security is sold, however, the fund realizes the gain and must pay a distribution unless the gain is offset by capital losses. Consequently, a fund’s capital gain distribution in a particular year is a result of the sale of securities that may have appreciated in value, perhaps during prior years when the fund’s returns were positive.
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Q: Do the American Funds try to limit capital gain distributions?
A: We are mindful about the taxes our shareholders pay on capital gain distributions. While taxes are an important consideration, however, careful portfolio management is our primary objective; this means that securities will be sold when it is appropriate for investment reasons.
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Q: Why does the fund’s share price drop when a capital gain distribution is paid?
A: When profits from sales of securities outweigh losses, they accumulate and contribute to the rise of the net asset value (NAV) of the fund’s shares. When that profit is paid out to shareholders its NAV, or share price, is reduced by the amount of the distribution.
Example: Say a fund share sells at an NAV of $10. If sales of the fund’s securities have resulted in the fund making a capital gain distribution of $2 a share during the year, $2 will be deducted from the NAV and paid to shareholders on a specified date. On that date the fund share price will decline to $8.
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Q: Do I lose money when a capital gain distribution is paid?
A: No. You still have $10 in value — $8 in the fund’s NAV, and $2 in your pocket or reinvested in the fund. And if you do automatically reinvest your capital gain distribution, it buys you additional fund shares at the new, lower price of $8. These additional shares compensate for the drop in the NAV, so the total value of your account doesn’t change. (Of course, if there is a decline in the market at the same time, you may still see a drop in the total value of your account.)
Example: Let’s say you have 100 shares in your account. At an NAV of $10 a share, your account value is $1,000. If the fund pays a capital gain distribution of $2 a share, the NAV drops to $8, and your original 100 shares are now worth $800. If you reinvest your capital gain distribution, however, it will automatically buy you $200 worth of shares — at $8 per share. You’re able to add 25 shares to your account, so you now own 125 shares worth $8 each. That’s a total of $1,000, which was your original account value before the capital gain distribution was paid.
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Q: When do I have to pay taxes on my capital gain distributions?
A: You are required to include these amounts on your federal income tax return. This is true even if you reinvested your capital gain distributions or if the fund’s share price declined during the year.
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Q: How can I learn about these funds’ capital gain distributions?
A: You may obtain per-share information from:
- americanfunds.com — year-end capital gain distributions
- American FundsLine — our 24-hour automated phone service — at 800/325-3590
- Shareholder Services Representatives at 800/421-0180*
- your financial professional
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Q: How can I find out the amount of each fund’s capital gain distribution?
A: You can obtain the per-share amount from any of the resources listed above. The capital gain distributions you receive will be reported on your year-end account statement and on your Form 1099-DIV, which will be mailed to you in January of each year. Note: Even if a fund does not pay a capital gain distribution, it may pay dividends, which would generate a 1099-DIV form reporting the amount of these dividends.
*Shareholder Services Representatives are available from 8 a.m. to 8 p.m. Eastern time, Monday through Friday. If you are outside the U.S., contact your operator to call us collect at 757/670-4900 between 8 a.m. and 5 p.m. Eastern time, or 949/975-5000 between 11 a.m. and 8 p.m., Monday through Friday.