What is return of capital?
In one line: Return of capital is the part of a fund's payout that counts as your own money handed back, so it lowers your cost basis instead of being taxed when it arrives.
How it works
When a fund pays out more than it earned, the extra is labelled return of capital, or ROC. It's treated as part of your own money coming back to you.
You usually don't pay tax on it when it arrives. Instead, it lowers your Cost basis, what you count as having paid. The tax shows up later, when you sell, as a bigger gain or a smaller loss.
Many income funds, like a Covered-call ETF, report part of the payout this way. The year-end tax slip says how much:
- US: Form 1099-DIV, box 3, "nondividend distributions." If your basis hits zero, any more ROC is taxed as a capital gain.
- Canada (a Canadian-listed fund): the T3 slip, box 42, lowers your adjusted cost base (ACB). If ACB would go below zero, the negative amount counts as a capital gain.
Rules are as of October 2026. The IRS (Publication 550) and the CRA explain them.
An example (hypothetical)
An illustration, not a trade idea. You buy 100 shares of a fund at $20, so your basis is $2,000. Over a year it pays out $240. Its tax slip says $150 of that was return of capital.
Your new basis: $2,000 − $150 = $1,850, or $18.50 a share.
| You sell 100 shares at | Gain or loss on old basis | Gain or loss on new basis |
|---|---|---|
| $21 | +$100 | +$250 |
| $18.50 | −$150 | $0 |
| $17 | −$300 | −$150 |
At $17 your shares fell $300. Add the $240 paid out, and you're down $60 overall. But the tax loss you can claim is only $150, because $150 of the payout was your own money.
Why it matters for sellers
A payout that's partly ROC isn't all earnings. A fund can pay a big rate while its share price slides, and ROC is often part of how. That slide is NAV erosion.
ROC isn't always bad. A fund can label payouts ROC for tax reasons even when it hasn't lost money. The test is the Total return: price change plus payouts, next to the plain index.
Selling your own covered calls, there's no ROC. The premium is simply your gain or loss on the option. The full worked year, US and Canada, is in return of capital in covered call ETFs. For how the funds are built, see how covered call ETFs work. For running the trade yourself, see the wheel strategy. Return of capital also matters less in a TFSA, RRSP or IRA, where gains aren't taxed when you sell.
Questions
Is return of capital free money?
No. It's part of your own money coming back. It lowers your cost basis, so you pay the tax later, when you sell.
Is return of capital taxed?
Not when it arrives, in most cases. It reduces your basis. Once your basis reaches zero, any more is taxed as a capital gain.
Where do I find how much was return of capital?
On your year-end slip: box 3 of Form 1099-DIV in the US, box 42 of the T3 in Canada. The fund also posts its breakdown on its site.
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