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Long‑term capital gain tax on mutual funds applies when you sell units held for longer than a specified period and earn a profit. The rules differ for equity‑oriented and debt‑oriented funds, and the tax rate depends on the holding period, fund type, and capital‑gain amount. Knowing these basics helps you plan redemptions in a more tax‑efficient way and estimate your net returns more realistically.
Key Takeaways
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Equity-oriented funds are taxed at 12.5% on long-term gains above ₹1.25 lakh after 12 months.
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Debt funds bought before April 1, 2023, qualify for LTCG after 24 months, while those bought later are taxed at slab rates regardless of holding period.
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Short-term gains on equity funds are taxed at 20%, while non-equity funds are taxed at applicable slab rates.
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The ₹1.25 lakh annual exemption on equity LTCG applies under Section 112A, subject to specified conditions.
Mutual Funds and Their Holding Periods
The holding period of your mutual fund investment decides whether the gains are taxed as short‑term or long‑term, and this, in turn, affects the tax rate you pay. The rules for this holding period are different for equity‑oriented and debt‑oriented funds.
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Equity‑oriented Mutual Funds: Equity‑oriented and equity‑oriented hybrid mutual funds are treated as long‑term if held for more than 12 months, so investors qualify for long‑term capital gains tax treatment from that point onward. Long‑term gains above ₹1.25 lakh in a financial year are taxed at 12.5% (plus applicable cess).
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Debt‑oriented Mutual Funds: Debt mutual funds purchased before April 1, 2023, are treated as long‑term if held for more than 24 months, and long‑term capital gains on such units are taxed at 12.5% without indexation. For investments made on or after April 1, 2023, gains are taxed at your applicable income‑tax slab rate, regardless of the holding period.
How Mutual Fund Returns are Taxed
Mutual fund returns are taxed differently based on the type of scheme and the holding period you follow, as per the applicable rules. The treatment is broadly divided into short‑term and long‑term capital gains.
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Equity-oriented funds: These funds invest at least 65% in equities. If held for more than 12 months, the gains are treated as long‑term, and long‑term gains above ₹1.25 lakh in a financial year are taxed at 12.5% without indexation benefit.
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Non-equity-oriented funds: These funds mainly invest in debt instruments. If purchased before April 1, 2023, and held for more than 24 months, gains are treated as long‑term and taxed at 12.5% without indexation. If purchased on or after April 1, 2023, gains are taxed at your applicable income‑tax slab rate, regardless of the holding period.
Ways To Reduce Tax on Long-Term Capital Gains from Mutual Funds
While tax cannot be completely avoided, certain provisions under the Income Tax Act can help reduce the liability on mutual fund long-term capital gain, as per rules. These options allow investors to plan their redemptions more efficiently.
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Utilise the exemption threshold: For equity‑oriented funds, long‑term gains up to ₹1.25 lakh in a financial year are tax‑free and spreading redemptions across years can help you stay within this limit. You can also avoid lump sum redemptions and stagger them to avoid exceeding the exemption limit.
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Practice tax-loss harvesting: If you hold investments that are currently in a loss position, you can sell them to book that long-term capital loss. This loss can then be used to offset your profitable gains from other funds, reducing your overall tax liability; if your losses exceed your gains, you can carry them forward for up to 8 assessment years to offset future gains.
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Opt for Systematic Withdrawal Plans (SWP): SWPs are highly tax-efficient because each withdrawal consists of both your original investment (principal) and the capital gain. Since only the gain component is taxable, spreading your withdrawals over time allows you to keep the taxable portion within the annual ₹1.25 lakh exemption limit, often resulting in little to no tax on your cash flow.
Types of Mutual Funds and Their Long-Term Capital Gain Tax
There are different types of mutual funds, and each type is taxed separately. Here’s a table to understand the taxation on each type of mutual fund.
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Mutual Fund Type |
Applicable LTCG Tax |
|
Equity Funds |
12.5% on gains above ₹1.25 lakh with no indexation |
|
Equity-Oriented Hybrid Funds |
12.5% on gains exceeding ₹1.25 lakh, similar to equity funds |
|
Debt Funds and Debt-Oriented Funds |
Taxed at 12.5% without indexation if >24 months; post-2023: slab rates |
|
Unlisted Equity Funds |
12.5% on LTCG (held >24 months), without indexation (effective 23 July 2024). |
Note: For other hybrid funds (35%–65% equity allocation), LTCG applies after 24 months and is taxed at 12.5% without indexation (no ₹1.25 lakh exemption). STCG is taxed at slab rates.
Equity Mutual Funds
These mutual funds invest in the equities of different companies that can offer potential returns.
Under equity funds, tax-saving funds are available, popularly known as Equity-Linked Savings Scheme (ELSS). ELSS funds come with a lock-in period of 3 years, where the investor cannot sell or redeem their fund units till the end of the lock-in period.
There are other equity funds, which do not have any lock-in period. These funds allow the investor to sell or redeem their funds at any time from the date of purchase. The capital gains on these equity funds are taxed as per the holding period. Long‑term capital gains above ₹1.25 lakh are taxed at 12.5% + applicable cess, and no indexation benefit is provided.
For example, assume you have invested ₹5 lakh in an equity fund and sold the fund after 4 years for ₹7 lakh. In this case, the capital gain is ₹2 lakh (₹7 lakh – ₹5 lakh). As the capital gains are more than ₹1.25 lakh, the gains are taxed at 12.5% + applicable cess.
Cess is a type of tax that is collected by the state or central government for a specific purpose, such as education or healthcare, and it is separate from the regular income tax.
Equity-Oriented Hybrid Funds
These funds invest in equity and debt funds. In equity‑oriented hybrid mutual funds, over 65% of the investment is made towards equity or equity‑oriented securities. Hence, these funds are treated as equity‑oriented schemes for tax purposes, and long‑term capital gains on them are taxed at 12.5% on gains above ₹1.25 lakh in a financial year.
Debt Funds and Debt-Oriented Funds
Debt funds and debt-oriented funds invest in fixed-income assets, including government bonds, corporate bonds, treasury bills, and money market instruments. These funds strive to create consistent income while also preserving funds, making them ideal for investors with a reduced risk tolerance or those looking for stability in addition to equity exposure.
Debt funds purchased before 1 April 2023 qualify for long‑term capital gains and are at 12.5% (without indexation) if held for more than 24 months. For debt funds purchased on or after 1 April 2023, gains are taxed at your applicable income‑tax slab rate regardless of the holding period.
Unlisted Equity Funds
These are mutual funds that invest in shares of privately held companies that are not traded on public stock exchanges. The long‑term capital gains on these funds are taxed at 12.5% on LTCG (>24 months holding) without indexation.
What Determines the Tax on Mutual Funds?
The factors that determine the tax on mutual funds are the type of mutual funds, investment holding period, capital gains amount, and whether any dividends are offered on the fund.
How Are Long-Term Capital Gains Calculated on Mutual Funds?
Let us consider an example to understand how to calculate the LTCG on mutual funds. Assume you have invested in an equity mutual fund of ₹2,00,000 for 4 years and sold the fund units for ₹7,00,000.
First, calculate the profit on the investment. As per the example, you made a profit of ₹5,00,000. As this is an equity fund, there is no indexation benefit offered. And the capital gains are more than ₹1.25 lakh, so the LTCG is taxed at 12.5% + applicable cess. This way, based on the fund type, holding period and capital gain amount, you can calculate the taxation.
Tax Exemptions on Capital Gains
Long-term capital gains on mutual funds are subject to limited exemptions under the Income Tax Act. These depend on the fund type and nature of the asset.
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Annual Exemption under Section 112A
Long-term capital gains from equity-oriented mutual funds up to ₹1.25 lakh per year are tax-free. Gains beyond this threshold are taxed at 12.5%. This exemption is applicable to the entire qualified profits from equities shares and mutual funds combined.
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Set-Off of Capital Losses
Long-term capital losses may only be offset against long-term capital profits. Short-term losses can offset both short-term and long-term profits. Unused losses can be carried forward for up to eight years if taxes are filed on time.
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Section 54F (Limited Applicability)
Section 54F exempts gains from certain long-term assets that are reinvested in a residential property within certain time frames. However, this provision does not often apply to equity mutual funds.
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Section 54EC (Not Applicable to Mutual Funds)
Exemption under Section 54EC is only applicable for gains from the sale of property or buildings when invested in certain bonds. It is not applicable to mutual fund investments.
Conclusion
While investing, make sure that you are well aware of the taxes levied on your investment gains. This way, you know how much you can expect from an investment approximately and adjust your investment goals accordingly.
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