Mutual fund investing is a preferred investment type among investors wanting to accumulate wealth. However, it is equally important for them to know the tax implications. One of the crucial areas that each investor needs to understand is the Long-Term Capital Gains (LTCG) tax. This tax is levied on the gains arising from holding mutual fund investments for a longer time.
Understanding how long-term capital gain tax on mutual funds can assist you in making better financial choices and maximising your returns. Let us understand the basics of LTCG tax on mutual funds.
What Qualifies as Long-Term Capital Gains Tax on Mutual Funds?
The tax on long-term capital gains on mutual funds in India is gains made from selling units of a mutual fund held for more than a certain duration, as opposed to short-term gains. Whether these gains qualify as long-term or not would depend on the nature of the mutual fund and the holding period of the investment.
- Equity-Oriented Mutual Funds: These mutual fund investments have a minimum of 65% in listed domestic equity shares units that are invested for over 12 months. So, they are eligible for long-term capital gains.
- Other Than Equity-Oriented Mutual Funds: For non-equity-oriented plans, the holding period to qualify as a long-term capital gain is over 24 months.
It is important to understand these categorisations since they decide the respective tax rates that can be charged and any incentives, impacting the post-tax yields on your investments.
How is LTCG Tax on Mutual Funds Calculated?
Knowing important terminologies is important to determine the long-term capital gain tax in a mutual fund. The cost of acquisition is the initial price one pays to buy the mutual fund units. Hence, the investor receives or pays the full value of consideration when selling the units.
Calculating LTCG involves subtracting the cost of acquisition from the full value of consideration. For equity-oriented mutual funds, LTCG is taxed at 12.5% if gains exceed ₹1.25 lakh per fiscal year. For non-equity-oriented funds, such as debt funds, LTCG is taxed at the investor’s applicable income tax slab rate if held for more than 24 months.
To calculate LTCG, subtract the cost of acquisition from the sale price. If the gains exceed the exemption limit, the applicable tax rate is applied. For instance, for equity funds, gains above ₹1.25 lakh are taxed at 12.5%. This calculation helps investors understand their tax liabilities when selling mutual fund units.
Strategies to Reduce LTCG Tax on Mutual Funds
To reduce the long-term capital gains tax rate on mutual funds, planning is necessary. Some efficient strategies that investors can use are listed below:
1. Tax Harvesting
This strategy calls for the periodic sale of equity mutual fund units to book profits within the ₹1.25 lakh tax-free bracket and invest in the same scheme. Moreover, Investors systematically book profit without crossing the exemption threshold to avoid LTCG tax on their earnings. For instance, an investor who redeems ₹3.60 lakh worth of units after making a capital gain of ₹60,000 is tax-free, as the gains are under the taxable bracket.
2. Balancing Capital Losses
Capital losses on poor-performing investments may be utilised for balancing LTCG on mutual funds. When an investor realises a ₹40,000 loss, this is deductible from long-term gains within the same year of income, thereby decreasing taxable income and diminishing tax liability.
3. Section 54F Exemptions
Investors selling mutual funds units can invest the net consideration amount in real estate (maximum of two properties) to invoke exemptions under Section 54F. Additionally, the investment should be made within two years (within three years in the case of under-construction property) to benefit from this relief.
Final Thoughts
It is important to understand LTCG on mutual funds to make informed investment choices and maximise returns. With the help of tax-saving measures like tax harvesting and counterbalancing capital losses, investors can successfully minimise their tax outgo. Staying updated on tax rules and strategically planning redemptions can increase overall financial returns. Furthermore, intelligent tax planning helps your hard-earned gains stay maximised.
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