A mutual fund may sell appreciated holdings and distribute realized gains to shareholders. In a taxable account, that distribution can be taxable even if the investor never sold fund shares.
The share price adjusts
The fund price generally falls by the distribution amount, so the payment is not free extra return.
Purchase timing can matter
Buying shortly before a distribution can create taxable income tied to gains earned before the investor arrived.
Account type changes the effect
A distribution inside a tax-advantaged retirement account generally does not create the same current tax event.
Sources
- U.S. Securities and Exchange Commission, Mutual Fund Distributions.
- Internal Revenue Service, Publication 550.