Mutual funds often distribute year-end capital gains that are taxable at long-term or short-term capital gain tax rates.
Purchasing mutual funds in the fourth quarter may leave investors with a surprise tax bill.
Investors should review their mutual funds’ estimated capital gains prior to year-end and consider ways to potentially reduce tax burdens.
What are the Main Features of a Mutual Fund?
Mutual funds are a popular way to access professionally managed equity strategies, usually with the intent of driving outperformance. Mutual funds trade once per day at market close and are priced at net asset value.
Mutual fund managers typically trade throughout the year and build up a net profit on the sale of appreciated securities. Other factors such as shareholder redemptions and tax-loss harvesting may impact the net profit on the sale of securities. Mutual funds are required by federal tax law to distribute net realized capital gains, which tends to happen at year end.
What are Mutual Fund Capital Gain Distributions?
Capital gain distributions are the net realized short-term or long-term gains that mutual funds distribute to investors. This results in a potential tax bill at the end of each year, even if the investor does not sell their mutual fund position.
Short-term capital gains are taxed at ordinary income tax rates, whereas long-term capital gains are taxed at the following rates based on the investor’s taxable income:
The size of capital gain distributions can vary by fund and year, and it typically ranges from 5 - 10% of the mutual fund’s net asset value. However, certain other factors such as high turnover in the year can lead to much higher capital gain distributions.
When a capital gain distribution is paid, the net asset value of the mutual fund is simultaneously reduced by the amount of the distribution. This results in a lower unrealized gain, or even an unrealized loss for the investor's position, while the investor is still responsible for taxes on the distribution.
Three Ways to Reduce the Tax Burden of Mutual Fund Investing
Mutual fund companies publish estimates of their year-end capital gain distributions in advance, allowing investors to make informed decisions about reducing the potential tax burden.
We highlight three strategies that RISE Investments leverages in client portfolios to navigate mutual fund capital gain distributions.
1) Consider Investing in an Exchange-Traded Fund (ETF) Instead
Investors can likely avoid capital gain distributions by investing in an ETF as opposed to a mutual fund. ETFs are highly tax-efficient investment vehicles that rarely distribute capital gains. ETF strategies tend to be passively managed and seek to match an index’s performance, unlike actively managed mutual funds that seek outperformance.
ETFs have become popular with investors. According to EPFR Global, roughly $972 billion has flowed into equity ETFs during 2025 [2].
2) Sell the Mutual Fund Before the Ex-Date
An investor may sell a mutual fund prior to the mutual fund’s ex-dividend date (or “ex-date”). The ex-date is the first day the mutual fund trades without the right to receive the capital gain distribution. Investors should consider selling the mutual fund in advance of the ex-date if the tax consequences of selling would be more favorable than staying invested and receiving the capital gain distribution.
Selling a mutual fund prior to the ex-date would likely lead to a more favorable tax outcome than retaining the position if the investor has an unrealized loss on their mutual fund position and the mutual fund is expected to make a capital gain distribution. In this scenario, the investor should consider using the mutual fund sale proceeds to buy an ETF with similar exposure or another mutual fund with similar exposure that has already paid its capital gain distribution.
3) Use Tax-Deferred or Tax-Free Accounts to Invest in Mutual Funds
Investors with tax-deferred or tax-free accounts, such as a Traditional or Roth individual retirement account (IRA), may consider using their IRA to hold mutual funds. Although the mutual funds will still pay capital gain distributions, the distributions are not taxable upon receipt.
Tax-efficient investments such as ETFs tend to make the most sense to be placed in taxable accounts, whereas less tax-efficient investments like mutual funds are more advantageous to be held in tax-deferred and tax-free accounts.
Conclusion
Proper planning around year-end capital gain distributions can easily lead to avoiding unexpected tax surprises. There are several proactive steps that can be taken today to minimize tax burdens.
Footnotes
[1] Does not include Medicare surcharge taxes or state capital gain taxes.
[2] Data is as of October 22, 2025.
Disclosure
RISE Investment Management, LLC ("RISE" or "RISE Investments") is an investment adviser registered under the Investment Advisers Act of 1940. Registration of an investment adviser does not imply any level of skill or training. This publication is solely for informational purposes and past performance is not indicative of future results. Any description of products, services, and performance results of RISE contained in this publication are not an offering or a solicitation of any kind. No advice may be rendered by RISE Investments unless a client service agreement is in place. Advisory services are only offered to clients or prospective clients where RISE Investments and its representatives are properly licensed or exempt from licensure. All of the information in this publication is believed to be accurate and correct as the date set forth. RISE does not have or accept responsibility or an obligation to update such information. This article is for education purposes and should not be treated as tax or legal advice. This article is not a substitute for legal or tax advice from your professional legal or tax advisor.