LTCG Tax on Mutual Funds

What is Long Term Capital Gain Tax?

Long term capital gains tax is levied on the profit earned for more than ₹1.25 lakh from the sale or transfer of certain long-term assets, such as stocks, mutual funds, or real estate. LTCG tax rate varies based on the type of asset and the holding period. Following the Union Budget 2024, the LTCG tax rate (without indexation) was increased to 12.5%, up from 10%, for the FY 2024-25 (AY 2025-26), and it remains unchanged for FY 2025-26 (AY 2026-27) as well across all asset classes.

The capital gains tax indexation adjusts the purchase price of an asset for inflation, reducing taxable gains. This method was previously available for debt mutual funds for over 36 months. However, the new tax rules removed indexation for debt funds purchased after April 1, 2023. For assets purchased before this date, indexation will no longer apply if sold after July 23, 2024, and the 12.5% tax will be levied instead.

Long Term Capital Gain Tax on Mutual Funds

The LTCG Tax on mutual funds has undergone significant revisions, particularly for certain categories of mutual funds. These changes aim to streamline tax structures and impact the tax treatment of specific mutual fund types.

One key change is the revised definition of debt mutual funds in the Income Tax Act, which has come into effect from April 1, 2025. Under the new definition, a debt mutual fund must invest more than 65% of its total assets in debt and money market instruments, or in a fund-of-funds. Previously, debt mutual funds were defined as funds where no more than 35% of the total assets were invested in equity shares of domestic companies.

As a result, the tax treatment for investments made in specific mutual funds after April 1, 2025, has changed. These include categories like International Mutual Funds, Gold Mutual Funds, Balanced Hybrid Funds, and Fund of Funds (FoFs), where the debt portion is less than 65%.

Here’s how the Long term capital gain tax on mutual funds differs under the old and new rules:

*Long Term Capital Gain Tax rates on Mutual Funds w.e.f. April 1, 2025

LTCG Tax on Mutual Funds Exemptions

Several exemptions are available under the Income Tax Act for long-term capital gains. Here are the key exemptions:

• Section 54: Exemption available on gains up to ₹10 crores from the sale of residential property, provided the proceeds are reinvested in another residential property within the prescribed time frame.

• Section 112A: Provides exemption on gains up to ₹1.25 lakhs from listed equity shares, equity-oriented mutual funds, and units of business trust, enabling tax relief on equity-related investments.

• Section 54EC: Offers exemption on gains up to ₹50 lakhs from the sale of immovable property, when the proceeds are reinvested in specified bonds. These can be National Highway Authority of India (NHAI) Bonds, Rural Electrification Corporation Limited (RECL) Bonds, Power Financial Corporation Limited (PFCL) Bonds, or Indian Railway Finance Corporation Limited (IRFCL) Bonds.

• Section 54F: Exemption on proportionate gains from the sale of any capital asset (other than residential property) when the proceeds are used to purchase a residential property.

How to Calculate LTCG Tax on Mutual Fund?

Let's take an example to understand how to calculate the LTCG tax on mutual funds:

Mr. Sharma invests ₹3,00,000 in an equity mutual fund in January 2021. After holding the investment for over 12 months, he sold the mutual fund for ₹5,00,000 in January 2025.

Here’s a calculation illustration to help you understand better:

• Initial Investment: ₹3,00,000 in the mutual fund.

• Selling Price: ₹5,00,000 after 4 years.

• Total Long-Term Capital Gain (LTCG):

  • The total profit from the sale is ₹5,00,000 − ₹3,00,000 = ₹2,00,000.

• Exempt LTCG:

  • The first ₹1,00,000 of the LTCG is tax-free, per the annual exemption limit.

• Taxable LTCG:

• The taxable LTCG is ₹2,00,000 − ₹1,00,000 = ₹1,00,000.

• LTCG Tax @ 12.5%:

  • The tax payable on the taxable LTCG of ₹1,00,000 is 12.5%, which amounts to ₹12,500.

• Final Tax Payable:

  • The final tax payable on the LTCG is ₹12,500.

Note: No indexation benefit is available for equity mutual funds.

How to Save LTCG Tax on Mutual Funds?

Here are some smart ways to reduce your LTCG tax on mutual funds:

• Utilise the ₹1 lakh exemption each year: Redeem some mutual fund units annually to make the most of the tax-free LTCG limit every year.

• Invest in ELSS (Equity Linked Saving Schemes): These funds qualify for deductions under Section 80C, helping reduce your taxable income up to ₹1.5 lakh.

• Plan redemptions smartly: Avoid redeeming your entire investment at once. Spread withdrawals across multiple financial years to reduce tax liability.

• Switch funds cautiously: Switching from one mutual fund scheme to another is treated as a sale and is taxable. Make such decisions only when necessary.

Key Takeaways

Even with the LTCG (Long-Term Capital Gains) tax, mutual funds remain a strong option for long-term investing. LTCG deliver better post-tax returns than traditional savings products like fixed deposits. They also offer benefits like diversification, expert fund management, and easy access to your money. Once you're clear on the potential, you can confidently start SIP in Best Mutual Funds in India and build wealth over time through consistent investing.