What is a return of capital distribution and how is it taxed?

A return of capital (ROC) is a distribution that isn't paid out of the fund's or company's earnings, so the IRS treats it as giving you back part of your own investment rather than income. It's not taxed in the year received; instead it reduces your cost basis. That means a bigger taxable gain (or smaller loss) when you eventually sell. If ROC ever drives your basis below zero, the excess becomes a taxable capital gain. You'll see ROC reported in box 3 of Form 1099-DIV, common with some REITs, MLPs, and certain closed-end funds. Track it carefully, because your broker's basis should adjust automatically but errors happen, and forgetting to lower your basis means overpaying tax at sale.