When a mutual fund (or another regulated investment company) or a REIT sells holdings at a profit, it passes those net gains to shareholders as a distribution. They appear in box 2a of Form 1099-DIV.
How it is taxed
IRS Publication 550 says to report capital gain distributions as long-term capital gains, regardless of how long you owned your shares. They are not qualified dividends, but in practice they use the same 0%, 15% and 20% thresholds (for 2026, 0% up to $49,450 of taxable income for a single filer). Reinvesting the distribution in more fund shares does not avoid the tax; it does raise your cost basis.
Example
A single filer with $60,000 of taxable ordinary income owns a fund that pays a $1,200 capital gain distribution in December, even though the shares were bought in October. Because the income is above $49,450, the whole $1,200 is taxed at 15%: $180. Had the investor personally sold a stock held two months for a $1,200 gain, it would be a short-term gain taxed at 22%: $264.
Common mistake
Buying a fund shortly before its yearly distribution means receiving a taxable payout of gains earned before you owned it.
See how are dividends taxed and the capital gains calculator.