capital gain distributions are long-term capital gains generated by the fund from the internal sale of stocks it holds. by law, these gains must be passed out to the fundholders if a fund sells shares held short term at a gain they come out not as short term capital gains but as ordinary dividends. if a fund has net capital losses for the year the fundholder gets no tax benefit. those losses are carried over until such time as the fund has capital gains in excess of those losses.
in other words, funds must pass out the income (whether dividend, internet, capital gain or other income) they generate to the fundholders to keep their tax-exempt status.
