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How to Avoid LTCG Tax on Mutual Funds

Long-term capital gains tax (LTCG) can have an impact on overall returns from mutual fund exposures. There are several techniques available that can mitigate and/or avoid LTCG exposure. Some strategies include timing a withdrawal, tax-loss harvesting, and maximizing holding periods. For equity mutual funds, there isa  tax-free gain up to ₹1.25 lakh in a financial year. (Effective FY 2025-26). Therefore, timing and planning in your portfolio is important.

Union Budget 2025–26: Updated Taxation Rules for Mutual Funds

The Union Budget 2025–26 continued with reforms introduced in 2024, providing clarity for investors.

Key highlights:

  • Equity Mutual Funds:

    LTCG tax is levied at 12.5% for gains exceeding ₹1.25 lakh per financial year (no indexation benefit).

  • STCG (Short-Term Capital Gains):

    Short-Term Capital Gains Taxed at 20% if sold within 12 months.

  • Debt Mutual Funds (invested post-Apr 1, 2023):

    Taxed as per the investor’s income slab – no LTCG or indexation benefits apply.

  • Debt Mutual Funds (invested before Apr 1, 2023):

    Gains above ₹1.25 lakh taxed at 12.5% without indexation, provided they are held beyond 24 months.

  • Dividends:

    Taxed based on the investor’s income slab as DDT has been removed.

These rules emphasise long-term investing and better tax planning across mutual fund categories.

What is Long-Term Capital Gains Tax?

Long-Term Capital Gains tax applies to profits from the sale of capital assets such as mutual funds, stocks, or property held over a specified period.

  • Equity mutual funds:

    Gains after holding for more than 12 months.

  • Debt mutual funds:

    Gains after holding for more than 36 months (pre-April 2023 investments).

As per the latest update, LTCG is taxed at 12.5% for gains exceeding ₹1.25 lakh per year for both categories, where applicable.

What is Capital Gains Tax?

Capital Gains Tax is levied on the profit earned from selling a capital asset. It is classified as:

  • Short-Term Capital Gain (STCG):

    Higher tax rate; applicable on gains within 12 months for equity funds.

  • Long-Term Capital Gain (LTCG):

    Lower tax rate; applicable on gains after specified holding period.

Tax Implications on Mutual Fund Investments

Fund Type

LTCG Tax

STCG Tax

Equity Mutual Funds

12.5% on gains above ₹1.25 lakh/year

20% for holdings < 12 months

Debt Mutual Funds (Post-Apr 2023)

Slab rate on all gains, no LTCG benefit

Slab rate

Debt Mutual Funds (Pre-Apr 2023)

12.5% on LTCG over ₹1.25 lakh (if held >24 months)

Slab rate of <24 months

Hybrid Mutual Funds

Tax based on equity/debt ratio

Equity part taxed at equity rates

Can You Reduce Capital Gains Tax on Short-Term Investments

While it’s harder to reduce taxes on short-term gains, consider the following:

  • Tax-loss harvesting to offset gains with underperforming investments.
  • Switch to long-term investing for lower LTCG rates.
  • Use tax-advantaged schemes like ELSS for dual benefits.

How to Avoid LTCG Tax on Mutual Fund Investments

Use the strategies below to help reduce or avoid LTCG tax:

Systematic Withdrawal Plan (SWP)

Set up an Systematic Withdrawal Plan to redeem mutual fund units gradually. Keep annual withdrawals under ₹1.25 lakh to stay within the LTCG exemption limit.

Sell at the Right Time

Time redemptions to ensure your total annual gains do not exceed ₹1.25 lakh.

Tax-Loss Harvesting

Sell funds that are in loss to offset gains from profitable funds to reduce taxable capital gains.

Hold Longer

The longer you hold the funds, the better you are off to avoid higher tax liabilities and increase participation in compounding.

Review Portfolio Regularly

Monitor investments throughout the year to avoid surprises with the tax bill at year-end.

The Role of Tax Harvesting in Reducing Capital Gains Tax

Tax-loss harvesting helps investors offset taxable gains by selling investments that are currently at a loss.

As an example, if you have a ₹15,000 gain and a ₹5,000 loss, your taxable gain is now only ₹10,000. This especially works well at the end of the year.

You can carry forward unused capital losses for up to 8 years. Just make sure you do not repurchase the same or similar mutual fund within 30 days of the sale, to avoid wash-sale rules.

Why Holding Mutual Fund Investments for Longer Is Beneficial?

Long-term holding provides several tax advantages:

  • Gains up to ₹1.25 lakh from equity mutual funds are exempt.
  • Reduces transaction frequency and associated taxes.
  • Promotes compounding and wealth creation over time.

It also aligns with long-term investment goals while minimising tax disruptions.

Strategies to Minimise LTCG Tax Liability

Here are a few approaches to reduce your LTCG tax burden:

  • Stay invested long-term to utilise the ₹1.25 lakh LTCG exemption.
  • Avoid frequent redemptions that generate taxable events.
  • Consider tax-efficient mutual funds with lower turnover ratios.
  • Offset capital gains with harvested losses.

Selecting the Right Mutual Funds for Tax Efficiency

Fund Type

Tax Implication

Large-Cap Funds

Long-term investment ideal to stay under ₹1.25 lakh exemption.

Mid-Cap Funds

Higher volatility; hold long term to reduce LTCG tax impact.

Multi-Cap Funds

Diversification improves tax efficiency over longer investment horizons.

The Importance of Smart Investing for Tax Savings

Smart investing ensures your returns are maximised after tax. Key actions:

  • Hold mutual funds beyond required periods to qualify for LTCG rates.
  • Harvest losses strategically.
  • Use SWPs or phased redemptions to stay below annual tax exemption limits.

A disciplined and informed approach can significantly reduce tax outflows.

How to Calculate Capital Gains Tax on Mutual Funds?

Equity Mutual Funds (FY 2025–26 onwards)

  • Gains ≤ ₹1.25 lakh/year: No LTCG tax.
  • Gains > ₹1.25 lakh/year: 12.5% tax (no indexation).
  • STCG (held < 1 year): 20% tax.

Debt Mutual Funds

  • Post-Apr 2023 investments: All gains taxed as per income tax slab.
  • Pre-Apr 2023 investments: Gains taxed at 12.5% (LTCG) if held > 24 months; else taxed as per slab.

Hybrid Funds

  • The equity portion is taxed like equity funds.
  • The debt portion is taxed like debt funds.

Reducing the LTCG tax on mutual funds takes some planning, patience, and informed decision-making. Here's what you need to keep in mind:

  • Use the new exemption of ₹1.25 lakh on equity LTCG.
  • Stay invested long enough to access the preferred tax treatment.
  • Leverage tax-loss harvesting and good redemption techniques.

The tax changes from Budget 2024 and the changes to the rules for FY 2025–26 have made it easier to highlight the impact of tax-efficient investment planning.

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