The 2024 Union Budget introduced some significant changes to the taxation system. One of the most notable changes among them is the revision of the Long-Term Capital Gains and Short-Term Capital Gains tax. The LTCG tax rate for equity-oriented mutual funds has been increased from 10% to 12.5%, and the exemption limit on LTCG has been raised from Rs. 1 lakh to Rs. 1.25 lakh per year.
For debt-oriented funds, the LTCG rate has been increased from 15% to 20%. These increased rates have left many investors concerned about their post-tax returns, wondering how to avoid LTCG tax on mutual funds.
Here, we’ll take you through the workings of LTCG tax in mutual funds and look at some steps you can take to save more of your hard-earned money.
Understanding LTCG Tax on Mutual Funds
The capital gains tax on mutual funds depends on two factors – the type of mutual fund (like debt, equity, or hybrid) and the holding period of the investment. Here are the conditions where long term capital gain tax on mutual funds is applicable:
- Equity mutual funds (including equity-oriented hybrid funds): Profits made from such funds are considered long term capital gains when the investment is held for more than 1 year.
- Debt mutual funds (including debt-oriented hybrid funds): Capital gains from these funds are considered LTCG when the investment is held for more than 3 years.
Not only does the definition of LTCG differ based on the type of fund, but the applicable rates on LTCG tax on mutual fund investments also vary:
- For equity mutual funds and equity-oriented hybrid funds, the LTCG tax rate has been increased from 10% to 12.5% on gains above Rs. 1.25 lakh per financial year.
- On the other hand, for debt mutual funds and debt-oriented hybrid funds, the LTCG tax rate has been raised from 15% to 20% with indexation benefits. This is only applicable for investments made on or before 31st March 2023. Any debt mutual fund investment made after 1st April 2023, will no longer qualify for indexation benefits and gains will be taxed as per the investor’s income tax slab rate.
Let’s take an example to make LTCG on equity funds clearer. Suppose the long-term profit you made by investing in a large-cap fund was Rs. 3 lakh. Since the first Rs. 1.25 lakh are exempt from any tax, only Rs. 1.75 lakh will be taxed at capital gains. Thus the tax payable would be 12.5% of Rs. 1.75 lakh = Rs. 21,875.
Ways to Avoid or Reduce LTCG Tax on Mutual Funds
The best way to reduce LTCG on your investment is by taking professional advice from a mutual fund investment planner. They can not only minimise your tax liabilities but also help you maximise your returns by giving you personalised mutual fund recommendations. Keeping up with tax law changes can be quite tough. Only recently were the capital gains rules amended, and many changes to the tax structure were also announced in the 2025 Union Budget.
Professionals keep up with these changes and ensure your investment strategy saves you as much tax as possible. They can guide you on tax harvesting and reinvesting strategies, grandfathering rules, and portfolio rebalancing, and help you take maximum advantage of exemptions and deductions.
With that said, here are some ways one can reduce the LTCG tax on their mutual fund investments:
- Capitalizing on Losses (Tax-Loss Harvesting)
With this method, investors can use underperforming assets to offset capital gains. This means any investment which has incurred a loss can be sold to offset capital gains from other investments. For example, if one of your investments incurs a loss of Rs. 10,000, while the capital gains from the rest of your investments total Rs. 40,000, you can offset the capital gains by selling the loss-making investment.
Thus instead of booking Rs. 40,000 as taxable capital gains, you will only be taxed on Rs. 30,000 (Rs. 40,000 – Rs. 10,000). That’s why this strategy is known as tax-loss harvesting, as it helps reduce your overall tax liability by harvesting losses to balance out gains.
While this strategy can be used to reduce LTCG tax on mutual funds, selling with a short-term perspective just to save tax can be harmful to your financial goals in the long run. In the United States, if an investor sells an asset at a loss and buys the same or a substantially identical asset again within 30 days, a special provision, called the Wash Sale Rule disallows them from claiming the capital loss for tax purposes.
This is done to discourage tax evasion. In India, there are no such explicit regulations, however, doing this can result in an inquiry by the Income Tax Department. That’s why it’s critical to seek advice from a tax consultant before taking on such strategies.
- Holding Period Strategy
As stated before, the tax on long term capital gains is charged at a lower rate compared to short-term capital gains. Plus, LTCG are also exempt up to Rs. 1.25 lakh per financial year. Holding mutual fund investments for a longer period is quite advantageous not only due to these reasons but also because equity vehicles perform best over the long term.
- Using Grandfathering Clause (for Pre-2018 Investments)
The LTCG tax was reintroduced by the government in Budget 2018, so before that, there was no tax on long-term capital gains. Thus equity mutual fund investments held for more than a year were exempt from tax. Those who bought an equity mutual fund’s units before 31st January 2018 can use the grandfathering rule to save LTCG tax.
Grandfathering is a concept which allows old rules to continue applying to existing investments, even after new regulations are introduced. In this case, the grandfathering provision ensures that investors who purchased equity mutual fund units before 31st January 2018 are not unfairly taxed on gains made before that date, because at the time they invested, there was no tax on LTCG. Under this rule, the Cost of Acquisition (COA) is determined and defined as the higher of the actual purchase price of the investment, or the lower of the Fair Market Value as of 31st January 2018 or the sale price at which the asset is sold.
If the asset was not traded on that date, the highest price on the last trading day before it is considered the FMV. This means investors can use the highest market price on 31st January 2018 as their COA and reduce their taxable long-term capital gains and lower their LTCG tax liability.
Tax-Efficient Mutual Fund Strategies
- Opting for Tax-Saving Mutual Funds (ELSS)
Equity Linked Savings Schemes or ELSS are also called tax-saving mutual funds thanks to their status as a Section 80C investment option under the Income Tax Act. By investing in ELSS, investors can claim a deduction of up to Rs. 1.5 lakh per financial year and reduce their taxable income. These funds come with a lock-in period of 3 years, which is the shortest compared to other Section 80C investments like PPF, NPS, and SCSS.
An ELSS fund invests heavily in equities, which makes it a risky option. Investors should assess their risk tolerance before investing in them. Consulting a mutual fund advisor can prove to be a smart move here as they can assess your financial situation, goals, and risk tolerance and offer personalised advice.
- Choosing Dividend Plans vs. Growth Plans
While some companies pay out dividends to their investors, by investing in a growth plan one allows the mutual fund house to reinvest the dividends. This makes growth plans excellent long-term tools for wealth creation. Dividend plans or Income Distribution cum Capital Withdrawal plans, on the other hand, pay out dividends so the NAV does not grow as high.
After the abolition of the Dividend Distribution Tax, dividend income is taxed fully in the hands of the investors at their income tax slab rate. If the dividend income in a financial year exceeds Rs. 5,000, then the AMC is also mandated to deduct a 10% tax before crediting the dividends to the investors.
- Systematic Withdrawal Plan (SWP) for Tax Efficiency
Instead of redeeming the investment in a lump sum, investors can set up a Systematic Withdrawal Plan to withdraw a fixed amount of money periodically, such as monthly or quarterly. Since LTCG up to Rs. 1.25 lakh per financial year is tax-free, investors can structure their withdrawals in such a way that it helps them stay within this limit and minimises their long term capital gain tax on mutual funds.
Comparing LTCG Tax with Other Investment Taxes
- LTCG vs. STCG (Short-Term Capital Gains Tax)
In equity-oriented mutual funds, STCG tax is applicable when investments are sold within 1 year of purchase. The gains from such investments are termed STCG and are taxed at 20% with no exemptions, unlike LTCG which offers a Rs. 1.25 lakh tax-free limit.
The long term capital gain tax on mutual funds which are debt-oriented attracts 20% tax with indexation benefits if the investment was made before 31st March 2023. Any investment in debt funds made after the date has a different taxation system, where LTCG are added to the investor’s income and taxed as per their slab rate. If a debt fund is sold within 3 years of purchase, STCG tax is levied which is also added to the investor’s total income and taxed according to their income tax slab rate.
- LTCG Tax vs. Dividend Distribution Tax (DDT)
The Dividend Distribution Tax was abolished by the government during the Union Budget 2020. Now, the dividends received by an investor are classified under the head ‘Income from Other Sources’ and taxed as per their income tax slab. There are no exemptions available to offset dividend income, unlike the Rs. 1.25 lakh exemption offered by the government for LTCG tax on mutual fund investments. Moreover, if the annual dividend income exceeds Rs. 5,000, AMCs deduct a TDS of 10% under Section 194K.
- LTCG Tax vs. Fixed Deposit Taxation
Just like capital gains, income earned from fixed deposit interest is subject to taxation. Also like dividend income, interest earned from FDs is reported under the head ‘Income from Other Sources’ and taxed as per the investor’s income tax slab rate.
Fixed deposit interest is also subject to TDS. If an individual’s interest income exceeds Rs. 40,000 in a financial year from a single FD, the bank deducts 10% TDS (20% if PAN details are not provided) before crediting the interest. For individuals above 60, this limit is increased to Rs. 50,000 but TDS is deducted at the same rate.
The government offers senior citizens significant relief in the form of Section 80TTB of the Income Tax Act, which allows them to claim a deduction of up to Rs. 50,000 on accounts such as FD and RD.
Practical Steps for LTCG Tax Planning
Investing solely for the purpose of saving tax in the short term can be harmful to your long-term investment strategy. That’s why to get the most bang for your buck, you should consider taking advice from tax consultation services. They can help you understand how to avoid LTCG tax on mutual funds, minimise your overall tax liability, ensure compliance, and recommend vehicles that help you realise your long-term financial dreams.
Strategies like tax-loss harvesting can be complex, but professionals can guide you through the steps so you don’t land in trouble with the Income Tax Department due to non-compliance. Similarly, they can help you create a withdrawal plan that will help you take maximum advantage of the exemptions on LTCG. They can also assist you sort through ELSS funds so you can choose the ones that align with your risk tolerance and financial goals the most.
Conclusion
The long term capital gain tax on mutual funds is charged based on the type of fund one invests in. For debt funds, LTCG is applicable after selling the investment after 3 years from the date of purchase. Profits on debt fund investments made before 31st March 2023 attract a 20% LTCG tax with indexation benefits, while those made after the date are added to the investor’s taxable income and taxed according to their slab rate.
For equity-oriented funds, capital gains are considered long term when the investment is sold after being held for at least 1 year. The first Rs. 1.25 earned from LTCG per financial year are exempt, however, gains above this limit are charged at 12.5%.
Many ways such as investing in ELSS, making structured withdrawals, using the tax-harvesting strategy, grandfathering, and holding investments for longer can help investors reduce LTCG tax on mutual fund investments.
