Mutual funds pass on taxable capital gains and income to shareholders in the form of distributions. Distributions can be made monthly or quarterly, but most funds pay annually in November or December. These distributions are taxable to you, the shareholder, whether you reinvest or take them in cash. (In an IRA, pension or other tax-deferred account none of this tax planning applies to you.)
A capital gain distribution represents profit a mutual fund made by selling securities for more than they paid for them. The gain is considered long-term if the securities were held by the fund longer than one year; otherwise it is considered short-term. The tax status of a capital gain distribution is determined by how long the fund held the underlying security that was sold, not by how long you have owned the fund.
An ordinary income distribution represents interest and dividends paid by stocks and bonds owned by the fund. Income may be qualified or non-qualified.
In a taxable account, you may want to delay buying a fund until after its ex-dividend date, to sidestep a tax liability on an investment you just made, or consider ETFs which usually make smaller distributions. Most exchange traded funds (ETFs) do not make capital gains distributions, but ETFs can distribute income to shareholders.