How to Manage Capital Gains Distributions in 2025

Key Takeaways

• If mutual funds sold securities and realized gains, those gains need to be distributed to shareholders of record. Those distributions usually occur in November and December.
• It’s hard to estimate how big these distributions will be in late 2025, but the things that have contributed to them for the past several years are still very much in place.
• If an investor owns a fund that has indicated it will make a big distribution, selling preemptively often does not make sense.
• Investors should check the cost basis of their holdings to determine whether it’s advisable to sell out of a big capital gains distributor.
• If it looks like selling would trigger a big tax bill, investors can change their selection of where they have the fund distribute its income.

Margaret Giles: Hi, I’m Margaret Giles from Morningstar. With the fourth quarter well underway, mutual fund investors should keep an eye out for capital gains distributions from their funds, which can add to their tax burdens. Joining me to discuss how worried investors should be about big distributions in 2025 and what they can do about them is Christine Benz. She’s Morningstar’s director of personal finance and retirement planning and co-host of The Long View podcast. Christine, thanks for being here.

Christine Benz: Margaret, it’s great to see you.

What Are Mutual Fund Capital Gains Distributions?

Giles: Let’s start with a basic question. What are mutual fund capital gains distributions, and who do they affect?

Benz: Mutual funds need to distribute their gains. If they’ve sold securities and realized gains, those gains need to get distributed out to shareholders of record. And those distributions usually occur kind of in the November, December periods. Funds start publishing estimates of how much they expect to pay out. It’s important to note, Margaret, who is affected by these. If you own a mutual fund in a taxable account, so in a nonretirement account, you’re the person who’s going to potentially owe taxes on those capital gains distributions. Even if you reinvest the distributions back into your holdings, you still will owe taxes on those distributions. Who will not owe taxes are people who own funds in their tax-sheltered accounts. In their IRAs, in their company retirement plans. And that’s an important thing to note. This is kind of a nonissue for you if you are holding a fund in an IRA or some other tax-sheltered vehicle.

How Big an Issue Will Capital Gains Distributions Be in Late 2025?

Giles: For those holding these funds in taxable accounts, how big of an issue do you expect these distributions to be in late 2025?

Benz: It’s hard to estimate, but a lot of the things that have contributed to big capital gains distributions for the past several years are still very much in place. We have a great equity market that has prompted some fund managers to sell appreciated winners. We also have this trend of investors exiting actively managed funds and getting into exchange-traded funds in part to improve their tax efficiency. Because ETFs, for reasons that are beyond the scope of this conversation, do tend to be more tax-efficient. And that forced selling of the shareholders fleeing those actively managed funds causes managers to have to sell appreciated securities oftentimes. And then kind of a triple whammy here is that those distributions, because the shareholder basis has shrunk for a lot of actively managed funds, they’re getting dispersed across a smaller group of people. So, the people who have hung out, who are still holding the fund, are the ones who are having to pay taxes. So it’s not a great environment. We’ve seen this cycle going on for the past several years. I don’t see any signs of it abating.

Should Investors Sell Before a Big Distribution?

Giles: If an investor owns a fund that has indicated it will make a big distribution, does selling preemptively ever make sense?

Benz: It seems like it should, but often it doesn’t. And the reason is that fund shareholders have two sets of taxes to consider. The first set is the taxes that are triggered if your fund makes an income distribution, if it makes one of these capital gains distributions. These are sort of annual tax burdens that you face while you’re holding the fund. And then an additional set of taxes comes into play when you sell. So, if the security, if the fund has appreciated in value over your holding period, you’ll owe taxes on that spread between what you paid for it and what you’re selling it for. So you may be able to dodge that first type of tax coming your way, that capital gains distribution, but then you might also trigger your own capital gains bill if you’ve held the fund for a long time and you’ve experienced good returns in it. So proceed carefully. It doesn’t always make sense.

How Investors Can Check Their Cost Basis and Why It’s Important

Giles: You advise investors to check their cost basis in their holdings, determine whether it’s advisable to sell out of a big capital gains distributor. Where can investors find that information, and what does it tell them?

Benz: You should be able to find this either on your statement that you received or on your fund company’s website. Hop on there, look at what they have as your cost basis. It gets a little wonky because there are different ways of calculating cost basis, but the default for most mutual fund shareholders is an average of all of the purchases that you’ve made over time. Look at that, compare that to the fund’s current net asset value. You’re looking at your average purchase price relative to net asset value. If you have one of these, what I call a serial capital gains distributor, if you have a fund that is just distributed year after year, you might find that those numbers are fairly closely aligned. And the reason is that you’ve effectively, if you’ve been getting these capital gains distributions and paying the taxes, you’ve been stepping up your cost basis. You get an increase in your cost basis to kind of accommodate the fact that you are paying taxes on an ongoing basis. And so you might find that the spread between the net asset value for the fund and your own cost basis isn’t as much as you might think. So selling out of it, getting into something that’s more tax-efficient, like a broad market equity index ETF, can make a lot of sense.

How to Avoid Triggering a Tax Bill From Selling

Giles: Lastly, if it looks like selling would trigger a big tax bill, you think there’s another step investors can take. What is it?

Benz: I think we sometimes miss the magic of just unchecking those boxes where you have income getting distributed. Reinvested back into the portfolio, and your capital gains reinvested back into that fund as well. Uncheck that box. And so the capital gains, you’ll still get the capital gains payment. You may still owe taxes, but you can put the money into something that has more tax efficiency going forward. That’s kind of a middle ground, maybe sort of a chicken way to get out of that fund that hasn’t been great from a tax standpoint.

Giles: Well, I think that’s helpful to think about. Christine, thank you so much.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles from Morningstar. Thanks for watching.

Watch How to Rebalance Your Portfolio Before 2026 for more from Christine Benz and Margaret Giles.