Question:   How do return of principal payments affect my cost basis when I sell mutual funds?

Answer:   Unlike a dividend or a capital gain distribution, a return of capital:

• Reduces your basis in your mutual fund shares.
• A return of capital is a return of part of your investment (cost).
• Distribution cannot reduce your basis below zero.
• Once your basis reaches zero, any return of principal is capital gain and must be reported on Form 1040 Schedule D (PDF), Capital Gains and Losses.