Mutual fund units may attract capital gains tax when they are redeemed, sold, switched or otherwise transferred at a gain. The applicable treatment of STCG and LTCG on mutual funds depends on the fund category, unit acquisition date and holding period.
Since the rules differ across equity-oriented funds, specified mutual funds and other non-equity schemes, applying the same tax rate to every fund may result in an incorrect calculation. Here is how capital gain on mutual fund units is taxed under the rules applicable in 2026.
Table of Contents
What is capital gain on mutual funds?
Capital gain on mutual fund units is the gain realised when units are transferred for more than their permitted acquisition cost. A transfer may include redemption with the fund house, sale through a stock exchange or a switch from one scheme to another.
A rise in the scheme’s net asset value, or NAV, does not ordinarily create an immediate capital gains tax liability while the units continue to be held. The gain generally becomes relevant for tax purposes when a taxable transfer takes place.
When does capital gains tax apply to mutual funds?
Capital gains tax may apply to transactions such as:
- Redeeming units with the mutual fund.
- Selling exchange-traded fund or close-ended fund units on a recognised stock exchange.
- Switching from one mutual fund scheme to another.
- Switching between the growth and Income Distribution cum Capital Withdrawal, or IDCW, options of a scheme.
A switch is ordinarily treated as a redemption from one scheme and a fresh investment in another. It may therefore generate a taxable capital gain even when the money is not credited to the investor’s bank account.
Receiving mutual fund units through inheritance does not ordinarily trigger capital gains tax at that stage. A gift is also generally not treated as a transfer for capital-gains purposes, although receiving gifted units may have separate tax implications unless an applicable exclusion is available. When the recipient later transfers the units, the previous owner’s acquisition cost and holding period may become relevant.
What are STCG and LTCG on mutual funds?
Capital gains from mutual fund units are classified as short-term capital gains, or STCG, and long-term capital gains, or LTCG, according to the fund’s tax category and the period for which the units were held.
For equity-oriented mutual funds:
- Units held for 12 months or less generally generate STCG.
- Units held for more than 12 months generally generate LTCG.
The holding-period and taxation rules for LTCG on mutual funds can differ for specified mutual funds and other non-equity schemes. These rules are explained in the fund-wise taxation section below.
What factors determine tax on mutual funds?
The tax treatment of mutual fund gains generally depends on:
- Fund classification and portfolio: The scheme may qualify as an equity-oriented mutual fund, a specified mutual fund under Section 50AA or another non-equity fund.
- Acquisition date: Certain tax provisions apply only to units acquired on or after a specified date.
- Holding period: Where deemed short-term treatment does not apply, the holding period determines whether the gain is short-term or long-term.
- Transaction type: Redemption, exchange sale and switching may trigger capital gains, while IDCW income is taxed separately.
- Investor category: Tax rates and compliance requirements may differ according to the investor’s residential status, legal status and other circumstances.
The scheme’s name alone may not establish its tax classification. Portfolio composition is particularly relevant when determining the treatment of hybrid funds and fund-of-funds schemes.
Is IDCW income treated as a capital gain?
No. Capital gains may arise when mutual fund units are transferred for more than their permitted acquisition cost. Income distributed under the IDCW option is generally taxed separately in the investor’s hands under the applicable provisions.
An IDCW payment is not an additional or guaranteed return. The scheme’s NAV ordinarily falls by the amount distributed per unit, subject to the applicable accounting and tax treatment. IDCW should therefore not be viewed as an additional return over and above the value of the investment.
How is capital gain on mutual funds calculated?
Capital gain is broadly calculated using the following formula:
Capital gain = Full value of consideration – permitted cost of acquisition – eligible transfer expenses
Suppose an investor acquires mutual fund units for ₹2 lakh and later redeems them for ₹2.60 lakh. If no other adjustment or eligible transfer expense applies, the capital gain would be ₹60,000.
The entire redemption value is not treated as the capital gain. The gain is calculated first, after which the fund classification, acquisition date, holding period and relevant tax provisions determine its tax treatment.
Special rules may apply in certain situations:
- Units acquired before 1 February 2018 and covered by Section 112A may qualify for grandfathering provisions when determining their cost of acquisition.
- Units received through gift or inheritance may require reference to the previous owner’s cost and holding period.
- Eligible expenses incurred wholly and exclusively in connection with the transfer may be deductible, subject to the applicable provisions.
- Securities transaction tax is not treated as a deductible transfer expense when calculating capital gains.
The figures shown are for illustrative purposes only.
How are different types of mutual funds taxed?
The following is a broad overview of the principal tax categories for mutual fund units. Applicable surcharge and health and education cess may be additional.
Taxation of equity-oriented mutual funds
A scheme generally needs to meet the statutory domestic-equity investment requirements to qualify as an equity-oriented mutual fund for tax purposes.
For eligible equity-oriented mutual fund units transferred on or after 23 July 2024:
- STCG on units held for 12 months or less is generally taxed at 20% under Section 111A, subject to the applicable conditions.
- LTCG on units held for more than 12 months is generally taxed at 12.5% under Section 112A.
- The 12.5% rate generally applies to aggregate eligible LTCG exceeding ₹1.25 lakh in a financial year.
The ₹1.25 lakh threshold applies to aggregate eligible gains covered by Section 112A. It is not a separate threshold for every mutual fund scheme or transaction.
Source: Income Tax Department, FAQs on the new capital-gains taxation regime.
Taxation of specified mutual funds
From 1 April 2026, a specified mutual fund under Section 50AA generally means:
- A mutual fund that invests more than 65% of its total proceeds in debt and money-market instruments.
- A fund that invests 65% or more of its total proceeds in units of such a fund.
The prescribed percentage is calculated using the annual average of the daily closing figures.
Gains from covered specified mutual fund units acquired on or after 1 April 2023 are generally deemed to be short-term capital gains, irrespective of how long the units are held. These gains are ordinarily taxed at the investor’s applicable rate.
Units acquired before 1 April 2023 are not brought under the deemed short-term treatment merely because the scheme subsequently meets the specified-mutual-fund definition. Their treatment must be determined under the otherwise applicable provisions.
Source: Income Tax Department, Section 50AA.
Taxation of other non-equity mutual funds
A scheme that is neither an equity-oriented mutual fund nor a specified mutual fund under Section 50AA may fall into another non-equity category. This category can include certain gold, international, hybrid and fund-of-funds schemes, depending on their portfolios.
The tax treatment can depend on:
- Whether the units are listed or unlisted.
- The date on which the units were acquired.
- The applicable holding period.
- Whether the gain qualifies as short-term or long-term.
Listed units may generally qualify as long-term when held for more than 12 months, while a holding period of more than 24 months may apply to other units. Where a gain qualifies as long-term and is not covered by a special provision, it is generally taxed at 12.5% without indexation for transfers on or after 23 July 2024. Short-term gains are ordinarily taxed at the investor’s applicable rate.
These schemes should not automatically be grouped with debt-oriented specified mutual funds because their portfolio composition may lead to a different tax treatment.
How are hybrid mutual funds taxed?
Hybrid funds do not have one universal tax treatment. Their classification depends on their portfolio composition. Some may qualify as equity-oriented funds, some may fall under Section 50AA, and others may be taxed under the remaining non-equity rules.
Investors should check the scheme’s tax classification rather than relying only on labels such as aggressive, balanced or conservative.
How are SIP redemptions taxed?
An SIP does not receive separate capital gains tax treatment. Each instalment is an individual purchase with its own acquisition date, cost and holding period.
When units are redeemed, the first-in, first-out, or FIFO, method is ordinarily used to identify the units transferred first. A single redemption may therefore include units with different capital-gains classifications.
The tax information in this article is based on prevailing laws at the time of publishing the article and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.
How does capital gains tax affect mutual fund returns?
Capital gains tax reduces the gain retained by the investor after a redemption or sale. Its effect depends on the gain amount and classification, applicable tax rate and availability of any eligible threshold, exemption or loss set-off.
Capital gains tax does not change the scheme’s reported NAV performance. Instead, it affects the investor’s post-tax outcome. Exit loads and other transaction-related costs may further reduce the amount received.
How can investors manage capital gains tax on mutual funds?
Tax considerations should support an investment decision rather than become its sole basis. Investors may consider:
- Reviewing the holding period: Check the acquisition date and likely classification of the gain before redeeming units.
- Using eligible thresholds: Aggregate LTCG covered by Section 112A is generally exempt up to ₹1.25 lakh in a financial year.
- Setting off capital losses: Short-term capital losses may generally be adjusted against short-term or long-term capital gains, while long-term capital losses may generally be adjusted only against long-term gains.
- Accounting for switches: Switching schemes may trigger capital gains and an exit load even when money is not transferred to a bank account.
- Assessing tax harvesting carefully: Realising and reinvesting gains may change the acquisition cost and holding period and expose the transaction to costs and market movement.
Eligible unabsorbed capital losses may generally be carried forward for up to eight assessment years, subject to statutory conditions and timely filing of the income-tax return.
Source: Income Tax Department, Section 74.
Explore mutual fund options with Bajaj AMC
Capital gains tax is one consideration when selecting or redeeming a mutual fund. The scheme’s investment objective, asset allocation, Riskometer, costs and suggested investment horizon should also correspond with the investor’s financial goals and risk capacity.
Bajaj AMC offers schemes across different mutual fund categories and investment strategies. Investors can explore the available options and review the Scheme Information Document, factsheet and Riskometer before making an investment decision.
Explore mutual fund investment options from Bajaj AMC.
Conclusion
Capital gain on mutual fund units is not taxed uniformly across every scheme. The applicable treatment depends on the fund’s tax classification, acquisition date, holding period and type of transaction.
Identifying the correct category before redeeming, selling or switching units can help investors estimate their post-tax outcome more accurately. Tax implications should be considered alongside the scheme’s investment objective, risks, costs and suitability for the financial goal.
FAQs
How is capital gain on mutual funds calculated?
Capital gain is broadly calculated by deducting the permitted acquisition cost and eligible transfer expenses from the redemption or sale consideration. Its tax treatment then depends on the fund classification, acquisition date and holding period.
What is the tax rate for LTCG on mutual funds?
For eligible equity-oriented mutual funds, LTCG is generally taxed at 12.5% on aggregate qualifying gains exceeding ₹1.25 lakh in a tax year. The treatment of LTCG on other mutual funds depends on the scheme’s tax classification, acquisition date and applicable holding period.
What is the STCG tax rate on equity mutual funds?
Eligible STCG on equity-oriented mutual fund units transferred on or after 23 July 2024 is generally taxed at 20% under Section 111A. Applicable surcharge and cess may be additional.
Are debt mutual fund gains always treated as short-term?
No. Covered specified mutual fund units acquired on or after 1 April 2023 generally generate deemed short-term capital gains irrespective of the holding period. The treatment of older units and debt-related schemes outside Section 50AA may differ.
Is switching between mutual fund schemes taxable?
Yes. A switch is ordinarily treated as a redemption from one scheme and a fresh investment in another. It may therefore generate a taxable capital gain even when no money is withdrawn into the investor’s bank account.
Are there any tax benefits to investing in ELSS mutual funds?
An eligible ELSS investment may qualify for a deduction under Section 80C within the overall prescribed limit when the investor uses the old tax regime and meets the applicable conditions. Each investment has a three-year lock-in, while redemption gains are taxed under the rules applicable to equity-oriented mutual funds.
Are any exemptions or thresholds available for mutual fund capital gains?
Eligible aggregate LTCG from equity-oriented funds and other qualifying assets is generally taxed at 12.5% on the amount exceeding ₹1.25 lakh in a tax year. Eligible capital-loss set-offs and other statutory provisions may also reduce the taxable amount, subject to their conditions.
How are SIP gains taxed?
SIPs do not receive separate tax treatment. Gains on the units redeemed are classified using the acquisition details of the relevant instalments, which are ordinarily identified through FIFO.
