Nondividend Distributions

By Kaye A. Thomas
Current as of February 15, 2013

Tax treatment of mutual fund distributions that represent a return of capital.

Mutual funds sometimes make distributions that don’t represent earnings. When you receive this type of distribution, you’re considered to be getting back some of the money you invested in the company. That’s why these payments are sometimes called return of capital distributions. The IRS used to call them nontaxable distributions but now calls them nondividend distributions.

Don’t confuse these payments with exempt interest distributions. Those distributions represent interest received by the mutual fund from municipal bonds and similar investments. Return of capital distributions don’t come from exempt interest or from any other type of earnings.

Adjusting your basis

Before you can determine how to report your distribution, you have to take care of an important piece of business: adjusting the basis of your shares. Your basis is used to measure how much gain or loss you have when you sell your shares. You can think of it as a measure of how much you have invested in your shares. When you receive a return of capital, you’re getting some of your investment back, so your basis in the shares goes down.

If you’re using the average basis method to determine your basis, the basis adjustment is simple. Find the amount in box 3 of Form 1099-DIV and subtract that amount from the total basis of your shares.

If you’re using the separate lot method to determine your basis, you’ll need to take a few more steps:

  • Start with the amount in box 3 of Form 1099-DIV.
  • Divide that figure by the number of shares to which it applies. This tells you the amount of the adjustment per share.
  • Use this per-share basis adjustment to decrease the basis of each separate lot of shares you hold.

It would be highly unusual, but not impossible, to receive a nondividend distribution that exceeds your basis. In this case you reduce your basis to zero (not a negative number) and report the part that exceeds your basis as described next.

Reporting nondividend distributions

Unless your nondividend distribution exceeds your basis, you have nothing to report. Make the basis adjustment described above in your records so you can report the correct amount of gain or loss when you sell the shares, but don’t show this amount on your tax return.

In the rare case where your nondividend distribution is larger than your basis, you reduce the basis to zero — and report the additional amount of the distribution as capital gain on Form 8949.

 Example: At a time when your basis in your mutual fund shares is $170, you receive a nondividend distribution of $250. You’ll reduce your basis in the shares to zero — and report $80 of capital gain.

Report this amount as short-term or long-term gain, depending on how long you held your shares. You won’t receive Form 1099-B for this gain, so check Box C on the form. The IRS says to put the name of the payer in column (a) (description of property), and the amount taxable in column (d) (Proceeds) and column (h) (Gain or loss). For clarity, we suggest adding the words “nondividend distribution” in column (a).