Return of Capital

Form 1099-DIV box 3 and how it lowers your basis.

Educational information only, not tax, legal, or investment advice. Rules change; check the official sources listed on this page or talk with a qualified professional about your situation. Full disclaimer.

Some distributions from a stock or fund are not paid from the company's earnings and profits. These are nondividend distributions, often called return of capital. They are reported in box 3 of Form 1099-DIV and are common with REITs, MLPs, closed-end funds and some ETFs.

How it is taxed

  1. It is not taxed when received; it reduces your basis in the shares instead.
  2. Once your basis reaches zero, any further return of capital is taxed as a capital gain (long-term if you've held the shares more than a year).
  3. Your lower basis means a bigger gain (or smaller loss) when you sell.

Source: IRC § 301(c) and Pub. 550, "Nondividend Distributions."

Example 1: basis goes down

You buy 200 shares at $25 = $5,000. This year's 1099-DIV shows $300 in box 3. Your new basis is $4,700 ($23.50 per share). You pay no tax on the $300 this year.

If you later sell all 200 shares for $5,200, your gain is $5,200 − $4,700 = $500, not $200.

Example 2: return of capital in excess of basis

After years of distributions your remaining basis is $200. This year you receive $300 of return of capital. The first $200 reduces basis to $0; the remaining $100 is a capital gain, reported on Form 8949 and Schedule D. Every later box 3 distribution is a capital gain until you sell.

Example 3: different lots

Return of capital is applied per share. If you own 100 shares from Lot A and 100 from Lot B and receive $1 per share, each lot's basis drops by $100. One lot can hit zero before another.

Does my broker track this?

For covered securities, brokers generally adjust basis for return of capital they know about, often using the issuer's Form 8937. Distributions are sometimes reclassified after year-end, which is why corrected 1099s are common for these investments. For noncovered shares, keep a running basis yourself.

Frequently asked questions

Is return of capital tax-free income?

It is tax-deferred, not tax-free. It lowers your basis, so the tax shows up later when you sell (or immediately once basis reaches zero).

Where is return of capital reported?

Form 1099-DIV, box 3, nondividend distributions.

Sources

Last reviewed: November 2026