Return of Capital (ROC)

Return of capital (ROC) occurs when a fund distributes money that isn't derived from investment income or capital gains. Instead, it returns a portion of your original investment. While this sounds negative, ROC has both beneficial and concerning implications.

Types of ROC

Constructive ROC: Occurs naturally in certain structures like REITs, MLPs, and some ETFs due to depreciation deductions and timing differences. This can be tax-efficient.

Destructive ROC: Occurs when funds pay out more than they earn, effectively returning your own money to create an illusion of high yield. This erodes your investment.

Tax Treatment

ROC is not immediately taxable. Instead, it reduces your cost basis in the investment. When you eventually sell:

• Lower cost basis = higher capital gain
• You've essentially deferred taxes, not eliminated them
• If ROC exceeds your cost basis, excess becomes taxable gain

How to Identify ROC

• Check year-end 1099-DIV forms for Box 3 (Nondividend distributions)
• Review fund fact sheets for distribution breakdown
• Compare distribution rate to fund's total return over time

When ROC Is Acceptable

• REITs passing through depreciation benefits (expected and normal)
• MLPs with accelerated depreciation schedules
• Funds in temporary difficult periods with otherwise strong fundamentals

Warning Signs of Destructive ROC

• Consistently high ROC percentages (50%+ of distributions)
• Declining NAV over multiple years
• ROC used to maintain artificially high yields
• Distribution rate far exceeds underlying market returns