Gabelli Equity Trust's 10% Distribution Policy: A High-Yield Mirage or Sustainable Income Play?

In a market starved for yield, Gabelli Equity Trust (GAB) has long lured income investors with its 10% annual distribution policy. But as the fund's latest payout of $0.15 per share for Q4 2025 reveals, the sustainability of this high-yield strategy is increasingly tied to a precarious tax structure. With 43% of the distribution classified as return of capital-a figure that has risen sharply over the past five years-investors must ask: Is this a tax-efficient income stream, or a recipe for future headaches?

The Tax Breakdown: A Double-Edged Sword

According to a Marketscreener report, the 2025 distribution is estimated to consist of 6% net investment income, 51% net capital gains, and 43% return of capital on a book basis. While the 6% ordinary income component is relatively modest, the 43% return of capital-a non-taxable return of shareholders' original investment-reduces their cost basis. This creates a false sense of security: investors may enjoy immediate tax relief, but they risk higher capital gains taxes later when the shares are sold.

The trend is alarming. In 2020, return of capital accounted for 98% of distributions, according to a GuruFocus article, and by 2022, it had climbed to 100%, as reported by Benzinga. Even in 2021, when the fund reported 71% return of capital, as noted in a GuruFocus article, the pattern was clear. As Reuters reported, this shift reflects the fund's reliance on capital gains and shareholder equity rather than recurring income to fund its aggressive payout.

Sustainability Concerns: When Return of Capital Isn't Capital

The 10% distribution policy is technically tied to the fund's net asset value (NAV), but the Board's decision to distribute $0.15 per share-$0.06 above the policy's implied quarterly target-raises red flags, as noted in a Marketscreener report. Data from Morningstar indicates that GAB's NAV has been volatile, with periods of contraction that could strain its ability to maintain distributions.

A return of capital is not a sustainable income source. It essentially returns the investor's own money, eroding the fund's equity base over time. As noted in the 2022 10-K filing, the fund's 100% return of capital classification that year meant it was distributing capital rather than earnings, as reported by Benzinga. This practice, while legal, is a warning sign for long-term viability.

Tax Efficiency in a High-Yield Environment

On the surface, GAB's tax structure appears favorable. Long-term capital gains and qualified dividends are taxed at 20%, while return of capital is tax-deferred, according to a Marketscreener report. However, this efficiency is deceptive. For example, in 2021, the fund's 71% return of capital reduced shareholders' cost basis, potentially amplifying future tax liabilities, as noted in a GuruFocus article. If the fund's NAV declines, investors could face a "double whammy": a lower cost basis and a capital loss when selling.

Moreover, the 3.8% Medicare surcharge on net investment income adds another layer of complexity for high-income shareholders, as reported by Marketscreener. While the return of capital portion avoids this tax, the ordinary income and capital gains components do not. This creates a fragmented tax burden that varies by investor, complicating portfolio management.

The Path Forward: A Call for Caution

For income investors, the key takeaway is clear: GAB's 10% yield is not a free lunch. The fund's distribution strategy is increasingly reliant on capital gains and return of capital, which may not withstand prolonged market downturns or regulatory scrutiny. As the fund's 2025 press release, cited by Marketscreener, stated, the Board has signaled its intent to monitor NAV and market conditions, with potential adjustments to the distribution policy.

Investors should prioritize transparency. The final tax characterization for 2025 distributions will be reported on Form 1099-DIV in early 2026, as reported by Marketscreener, but historical patterns suggest continued reliance on return of capital. Those seeking sustainable income should diversify their portfolios and consider alternatives with stronger earnings-based payout ratios.

Conclusion

Gabelli Equity Trust's 10% distribution policy is a high-risk, high-reward proposition. While the current tax structure offers immediate benefits, the growing reliance on return of capital threatens long-term sustainability. Income investors must weigh these risks carefully, especially in a high-yield environment where alternatives are scarce. As the fund's NAV and Board decisions evolve, vigilance will be key to avoiding a payout that's more illusion than reality.