Capital Gains Basics

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Capital Gains Basics

What is a capital gain?
What is a long-term capital gain?
Why do mutual funds distribute capital gains?
Can a mutual fund pay a capital gains distribution if the fund's net asset value has fallen?
How do distributions affect the share price of a mutual fund?
What is meant by the "record date" for a distribution?
What is meant by the "ex-date" for a distribution?
What is meant by the "payable date" for a distribution?
What is the "wash sale" rule?

A capital gain occurs when a mutual fund manager sells a security in the portfolio that has gone up in value. A capital gain is also realized when you sell a capital asset, such as a stock or bond, for more than what you paid.

It's a gain on an investment that has been held for one year or longer. The maximum tax rate for a long-term capital gain is 15% through 2010.

It's a gain on an investment that has been held for less than one year. Short-term capital gains are taxed at the same rates as ordinary income and interest. Tax rates for short-term gains can range as high as 35%.

When a mutual fund generates income from its holdings or sells shares of stock and receives a capital gain, it is required by law to pay most of the income and gain, minus the fund's operating expenses, to its shareholders in the form of distributions.

Even if a fund's share price has fallen, it is possible for the fund to have realized capital gains on stocks that it sold during the year. For example, the fund could sell a stock that has gone up significantly since the fund bought it, but whose price has recently declined. If the price when the stock is sold remains higher than what the fund paid for it, the fund has still realized a gain, which it must pass along to its shareholders as a taxable capital gain. The fund could have gains in many individual stocks, but those gains may be outweighed by losses in other stocks, resulting in a lower net asset value.

On the day that a fund distributes a dividend or capital gains to shareholders, the fund's net asset value per share drops by the amount of the distribution per share. The drop in the net asset value does not reflect a loss in your overall investment value. Instead, it indicates that a portion of that value has been given to you as income or a capital gain. If you reinvest the distribution, the number of shares in your account will increase proportionally, so that the total value of your account will not be affected by the distribution.

This is the date when the fund determines which shareholders are entitled to a distribution of dividends and/or capital gains. Shareholders "of record"–those who own shares of the fund on the record date–receive the distribution. Those who invest after the record date do not.

This is the date when the distribution of dividends and capital gains is deducted from the mutual fund's assets and set aside for payment to shareholders. On the ex-date, the fund's share price (net asset value per share) drops by the amount of the distribution.

The date on which the declared dividend or capital gain distribution is scheduled to be paid to shareholders who elected to receive cash payments

As applied to a mutual fund investment, a wash sale is the sale of mutual fund shares and a purchase of shares of the same mutual fund within 30 days before or after the sale. The IRS does not allow investors to use a wash sale tactic for realizing a capital loss for tax purposes. If the transaction is subject to the wash sale rule, and if there is any loss on the sale (including a difference in value because of the sales charge that was paid), it is not recognized for federal income tax purposes and generally cannot be used to offset capital gains. Investors have to wait at least 30 days before repurchasing shares in a fund sold for a loss. Be aware that this waiting period could have a negative impact on your portfolio strategy, depending on market conditions. The wash sale rules are very complicated, so you should consult your professional tax adviser if you are considering such a strategy.

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Investors should consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus contains this and other important information about the fund. Contact your financial professional for a prospectus and read it carefully before investing.

An investment in our money market funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the funds.

Mutual fund investing involves risks. The investment return and principal value of an investment will fluctuate, and shares, when sold, may be worth more or less than the original cost. Keep in mind that asset allocation and diversification do not assure a profit or protect against loss in declining markets. Investors should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation.

Mutual funds are distributed by Prudential Investment Management Services LLC, a Prudential Financial company and member SIPC. Prudential Fixed Income Management and Prudential Real Estate Investors are units of Prudential Investment Management, Inc (PIM). Quantitative Management Associates, Jennison Associates, and PIM are registered investment advisors and Prudential Financial companies. Prudential Investments, Prudential Financial, the Rock Prudential logo, Jennison Associates, and Jennison are registered service marks of The Prudential Insurance Company of America, Newark, NJ, and its affiliates.

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