Long Term Capital Gain Tax on Mutual Funds

5paisa Research Team

Last Updated: 08 May, 2025 03:00 PM IST

Long Term Capital Gain Tax on Mutual Funds

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Investing in mutual funds is one of the most effective ways to build long-term wealth, offering investors diversification, professional management, and potential capital appreciation. However, understanding the tax implications of mutual fund investments is equally important to ensure maximum returns. One key aspect of mutual fund taxation is the Long-Term Capital Gains (LTCG) tax, which applies when an investor sells mutual fund units after holding them for a specific duration.

Recent changes in tax laws have revised LTCG tax rates, impacting how gains on mutual funds are taxed. Equity mutual funds now attract a 12.5% LTCG tax on gains exceeding ₹1.25 lakh, while debt mutual funds are taxed at the investor’s income tax slab rate without indexation benefits. These updates significantly influence investment strategies, making it crucial for investors to plan their investments efficiently and tax-effectively. 
 

What is Long-Term Capital Gains (LTCG) Tax?

LTCG tax is applied on the profit earned from the sale of mutual fund investments held for a long period. The tax rate varies based on the type of mutual fund and the holding period. The government encourages long-term investments by offering preferential tax rates to investors who hold their mutual funds for more than a specified duration.
 

Taxation Based on Mutual Fund Type and Holding Period

The taxation on mutual funds depends on whether you're investing in equity funds, debt funds, or hybrid funds, as well as how long you hold the investment.

Equity Mutual Funds and Equity-Oriented Hybrid Funds

Equity mutual funds primarily invest in stocks, while equity-oriented hybrid funds invest in both stocks and bonds, with the equity portion being more than 65%. The tax treatment for these funds is similar.

  • Holding Period: To qualify for LTCG tax, you must hold the investment for over 12 months.
  • Tax Rate: Gains above ₹1.25 lakh in a financial year are taxed at 12.5%, without the benefit of indexation.

For example, if you make ₹1.5 lakh from the sale of equity mutual funds and ₹1.25 lakh is exempt, you will be taxed at 12.5% on the remaining ₹25,000, which amounts to ₹3,125 in LTCG tax.

Debt Mutual Funds and Debt-Oriented Hybrid Funds

Debt mutual funds invest in fixed-income securities such as bonds, government securities, and other debt instruments. These funds have a different tax structure.

  • Holding Period: The holding period for LTCG tax on debt mutual funds is more than 36 months.
  • Tax Rate: LTCG tax on debt funds is now taxed as per the investor’s income tax slab rate. The indexation benefit has been removed as per the Finance Bill 2023.
     

How is LTCG Tax Calculated?

To calculate the LTCG tax on mutual funds, there are two key terms you need to understand:

  • Cost of Acquisition: This is the amount you originally invested in the mutual fund.
  • Full Value of Consideration: This is the amount you receive when you sell the mutual fund units.

Let’s take an example to illustrate this:

Imagine you invested ₹50,000 in a mutual fund and after holding it for over 12 months, you sold it for ₹3 lakh. The profit you’ve made is considered a long-term capital gain.

Step-by-Step Calculation:

Equity Mutual Fund Example

  • Exempted LTCG: ₹1.25 lakh
  • Taxable LTCG: ₹1.25 lakh (₹2.50 lakh - ₹1.25 lakh exemption)
  • Tax at 12.5%: ₹15,625

Debt Mutual Fund Example

  • LTCG Tax Rate: As per the investor’s income tax slab rate
  • Indexation Benefit: No longer applicable

Exemptions from LTCG Tax


Equity Mutual Fund Exemption

₹1.25 lakh of LTCG on equity mutual funds is tax-free per financial year. Any gains beyond this threshold attract a 12.5% tax.

Exemption under Section 54F

Under Section 54F, investors can claim LTCG tax exemption if they reinvest the sale proceeds into a residential property. The reinvestment must be made within one year before or two years after the sale, or construction must be completed within three years.
 

Impact of LTCG Tax on Your Investment Strategy

The new LTCG tax rules impact investment decisions, particularly for:

  • Equity Investors: The ₹1.25 lakh exemption still makes equity mutual funds a tax-efficient option for long-term investors.
  • Debt Investors: Removal of indexation benefits makes debt funds less attractive, as gains are now taxed at individual slab rates rather than a lower indexed rate.
  • Tax Planning: Investors should track their capital gains annually and consider selling equity mutual funds in tranches to stay within the ₹1.25 lakh exemption limit.
     

Conclusion

LTCG tax on mutual funds is an important aspect of your investment planning. By understanding the updated tax rates and exemptions, you can optimize your tax liabilities and improve your overall returns.

Whether you're investing in equity funds, debt funds, or hybrid funds, it's essential to keep track of the holding period and understand the tax implications before making a sale. For long-term investors, utilising tax exemptions and strategic capital gains planning can help maximise returns while ensuring tax efficiency.
 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing. For detailed disclaimer please Click here.

Frequently Asked Questions

Yes, ELSS offers higher return potential and a shorter lock-in of 3 years, compared to PPF’s 15 years. However, ELSS carries market risk, while PPF offers fixed, risk-free returns backed by the government.

Short-term capital gains tax applies to gains made from selling mutual funds within a specific holding period, while long-term capital gains tax applies to gains from investments held for longer durations.
 

After 3 years, profits from ELSS are treated as long-term capital gains. Gains up to ₹1.25 lakh in a financial year are tax-free. Gains exceeding this limit are taxed at a flat rate of 12.5%.

Indexation adjusts the purchase cost of debt funds for inflation, reducing taxable capital gains and thereby lowering the LTCG tax burden, especially for long-term investors holding the fund for over three years. However, it is important to note that indexation benefits are no longer available on debt funds.

No, ELSS is not taxed every year. Tax is applicable only when you redeem your units. Until redemption, your investment grows without any annual tax deductions on the gains, allowing compounding to work more effectively.
 

LTCG tax is applicable to both equity and debt mutual funds but differs in tax rates and exemptions based on the type of fund and the holding period.

You can legally avoid LTCG tax on ELSS by ensuring that your annual long-term capital gains from all equity investments remain within ₹1.25 lakh. Anything above that is taxed at 12.5%, without indexation.
 

If you sell mutual funds and switch to another fund, the sale triggers LTCG tax. Holding the investment for longer periods helps reduce the tax liability due to the preferential tax rates on long-term investments.
 

If your LTCG surpasses ₹1 lakh in a financial year, the amount exceeding this limit will be taxed at 12.5% for equity funds, while debt fund gains will be taxed as per your applicable tax slab.
 

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