How are capital gains distributions from mutual funds taxed?

Capital gains distributions from mutual funds are taxed at lower long-term capital gains rates. This taxation applies to the profits that mutual funds realize when they sell securities within the fund. When these profits are distributed to shareholders, they receive these distributions as capital gains.

The benefit of this taxation rate, which is typically lower than ordinary income tax rates, incentivizes investors by allowing them to keep more of their earnings from investments. Additionally, the long-term capital gains rates apply regardless of how long the investor has held their shares in the mutual fund, owing to how mutual funds distribute the gains. Regardless of any reinvestment of distributions, the tax liability is incurred based on the capital gains realized in that tax year when the distributions are made.