By Chirag Jain, Director of Research and Client Relations, Northbridge Wealth (ARN-41379)
Last updated: July 2026
When you redeem mutual fund units at a profit, the tax depends on two things: whether the fund is equity-oriented, and how long you held it. Equity funds held over 12 months pay 12.5% on long-term gains above ₹1.25 lakh a year, and the first ₹1.25 lakh is tax-free. Sell within 12 months and the rate is 20%. For most debt funds bought on or after 1 April 2023, the holding period is irrelevant. The entire gain is taxed at your income-tax slab rate.
Most articles on this still quote the old rates. The rules changed on 23 July 2024, and the definition of a “debt fund” changed again from FY 2025-26. Below are the current rules, worked examples, and the planning gap we correct most often.
A note on section references: this article uses the section numbering of the Income-tax Act, 1961, which applies to transactions up to 31 March 2026. The Income-tax Act, 2025 takes effect from 1 April 2026 and renumbers several provisions. The rates and logic are unchanged.
What changed, and why your sale date matters
The Finance (No. 2) Act, 2024 reset capital gains rules for transfers made on or after 23 July 2024. Three things moved at once:
- Equity short-term gains rose from 15% to 20%
- Equity long-term gains rose from 10% to 12.5%, and the annual exemption rose from ₹1 lakh to ₹1.25 lakh
- Holding periods were simplified into two buckets: 12 months for listed securities, 24 months for most others
Budget 2025 and Budget 2026 left these rates alone, so they apply for FY 2025-26 and FY 2026-27. If you hold units bought both before and after 23 July 2024, your redemption straddles two rule sets. The date of sale decides which grid applies.
How are equity mutual funds taxed?
A fund is “equity-oriented” if it invests at least 65% of its assets in Indian equities. These are taxed the same way as listed shares.
| Holding period | Tax rate | |
|---|---|---|
| Short-term (STCG) | 12 months or less | 20% (Section 111A) |
| Long-term (LTCG) | More than 12 months | 12.5% on gains above ₹1.25 lakh (Section 112A) |
The ₹1.25 lakh exemption rewards attention. It is per investor, per financial year, and it pools all your equity LTCG together across every equity fund and every direct share holding you own. It does not reset per fund. It does not carry forward if unused. This is where most families overpay, and we return to it below.
Worked example. Neha redeems equity fund units in FY 2025-26 with a total long-term gain of ₹1,70,000. The first ₹1,25,000 is exempt. She pays 12.5% on the remaining ₹45,000, a tax of ₹5,625 before cess. Had she realised only ₹1,25,000 of gains this year and the rest next April, her tax would have been zero.
How are debt mutual funds taxed?
Here, holding a fund for years no longer helps. Under Section 50AA, gains on debt-oriented funds bought on or after 1 April 2023 are treated as short-term regardless of how long you hold them, and taxed at your slab rate. There is no long-term concession, no indexation, and no ₹1.25 lakh exemption.
The definition of a “specified mutual fund” under Section 50AA was rewritten with effect from FY 2025-26. It originally caught any fund with 35% or less in domestic equity, which swept in gold ETFs and international funds. It now applies only to funds holding more than 65% in debt and money-market instruments. Gold and international funds have moved out of the slab-rate penalty box and follow the ordinary non-equity rules: 12.5% long-term after the relevant holding period. If you were told two years ago that your gold ETF was taxed at slab rate, that guidance is out of date.
Worked example. Ramesh redeems two debt-fund lots in 2026. A lot bought in March 2022, before the cutoff, held over four years, qualifies as long-term and is taxed at 12.5%. A lot bought in June 2023, after the cutoff, also held well over a year, is deemed short-term under Section 50AA and taxed at his 30% slab. Same fund, same investor. The purchase date alone more than doubles the rate on the second lot.
How are SIPs taxed?
Every monthly SIP instalment is a separate purchase with its own holding-period clock, and redemptions follow FIFO. One redemption can therefore contain both long-term and short-term gains.
The rule most SIP investors miss: your entire investment only becomes long-term 12 months after your last instalment. Redeem a 12-month equity SIP the moment it feels a year old and the most recent 11 instalments are still short-term, taxed at 20%. Waiting until 12 months past the final instalment converts all of it to 12.5%. On a large SIP, that timing gap is worth tens of thousands of rupees.
The gap we correct most often: the household exemption that goes unused
Here is the pattern we see repeatedly with families new to us.
The ₹1.25 lakh LTCG exemption is available to every individual taxpayer, every year. In a family, that is one exemption per member. A couple with two adult children who each hold investments have four separate ₹1.25 lakh allowances every year: ₹5 lakh of equity long-term gains that can be realised across the household tax-free, annually.
Most families never use it. They let equity gains accumulate untouched for years, then redeem a large block in one financial year, and a single ₹1.25 lakh exemption absorbs a fraction of a gain that could have been spread across several members and several years at zero tax. The gain was always going to be realised. The only questions were when, and in whose hands. Defaulting on both turns tax-free gains into taxable ones.
The fix is unglamorous. Each financial year, review the household’s unrealised equity gains and deliberately realise gains up to each member’s unused ₹1.25 lakh, reinvesting in line with the existing asset allocation rather than disrupting it. Done consistently, a family resets its cost base slightly higher every year at no tax cost, so that when a large redemption eventually comes, less of it is taxable. This uses an annual allowance the way the law intends, at the level a family actually operates. A single-account view of tax will always miss it.
One caution. Never realise a gain purely for the tax saving if it forces you to sell something you should be holding, or pushes you out of your intended allocation. The tax tail should not wag the investment dog.
Two rules worth knowing before you file
Short-term capital losses can offset both short- and long-term gains. Long-term losses can offset only long-term gains. Unused losses carry forward up to 8 assessment years, but only if you file your return by the due date. A late return forfeits the carry-forward.
Dividends (IDCW) are taxed at your slab rate, with 10% TDS above ₹5,000 per fund house under Section 194K.
What this means for your next redemption
The mechanics are simple. Fund type sets the bracket, holding period sets the rate. What separates families who keep more of their compounding is the annual discipline of realising the right gains, in the right hands, at the right time. The ₹1.25 lakh exemption used across a household every year is the clearest example of an allowance that is free to use and widely ignored.
Sources: Income Tax Department (incometaxindia.gov.in), Association of Mutual Funds in India (amfiindia.com), Finance (No. 2) Act, 2024.
Disclaimer: Northbridge Wealth is an AMFI-registered Mutual Fund Distributor (ARN-41379). This article is for general educational purposes only and does not constitute tax, legal, or investment advice. Tax rules are subject to change and their application depends on individual circumstances. Please consult a qualified tax professional before acting on any information here.
