🎓 Mutual Funds & Investment
Mutual Fund Taxation — LTCG and STCG Rules and the ₹1.25 Lakh Tax-Free Exemption
LTCG-STCG tax rules for equity, debt and hybrid mutual funds in 2026: 12.5% LTCG, the ₹1.25 lakh annual exemption, 20% STCG, and tax harvesting strategy explained simply.
Introduction
On FD interest, tax applies to the entire income; on mutual funds, tax applies only to the gains (capital gains) — and at different rates depending on the type. How long you held (holding period) and what kind of fund it is (equity or debt) — knowing just these two things makes your tax math clear.
Equity Mutual Funds (65%+ Shares)
| Holding Period | Type | Rate |
|---|---|---|
| Less than 12 months | STCG | 20% (no exemption) |
| More than 12 months | LTCG | First ₹1.25 lakh a year tax-free, then 12.5% |
Example: if an equity fund sold after 5 years yields a ₹3 lakh gain — taxable gain = 3,00,000 − 1,25,000 = ₹1,75,000; tax = 1,75,000 × 12.5% = ₹21,875. Had the same money sat in an FD and been taxed at slab rate, the bill would be considerably higher.
Debt Mutual Funds
The rules have changed — keep this in mind:
- Funds bought after 1 April 2023 no longer get the indexation benefit they once did.
- After the 2024 Budget: sell before 24 months and gains are taxed at slab rate; sell after 24 months and it is 12.5% (without indexation).
- So for a taxpayer in the 30% slab, debt funds are no longer the tax-saving vehicle they used to be.
Hybrid Funds — Where Most Mistakes Happen
- More than 65% equity (e.g. most BAF and equity savings funds): treated like equity funds — LTCG after 12 months, with the ₹1.25 lakh exemption.
- 35-65% equity (some dynamic asset allocation funds): the long-term cut-off is 24 months (reduced from 3 years in the 2024 Budget) — 12.5% after 24 months, but the ₹1.25 lakh exemption does not apply here.
So if you pick a BAF for an SWP, a fund with 65%+ equity gives a slight tax edge.
Tax Harvesting — ₹1.25 Lakh Tax-Free Every Year
The exemption doesn’t arrive automatically — you have to use it:
- At the end of each financial year (before March), calculate how much gain your holdings carry.
- Sell enough units to keep the realised gain within ₹1.25 lakh — the first ₹1.25 lakh of gains each year is tax-free.
- Reinvest the proceeds in the same fund immediately — the portfolio stays the same, but the cost basis goes up.
Done this way over 10 years, ₹12.5 lakh of gains can be made tax-free — on a large corpus, the saving runs into lakhs.
FD vs Mutual Fund — Tax at a Glance
| Aspect | Bank FD | Equity Mutual Fund |
|---|---|---|
| What is taxed | The entire interest | Only the gains |
| Rate | Slab (10-30%) | 12.5% (with the ₹1.25 lakh exemption) |
| Tax on monthly income (SWP) | Applicable | Most withdrawals are tax-free (return of capital) |
Related Reading
- The full math of monthly income in retirement: Post Office MIS vs SWP
- Calculate an SWP: SWP Calculator
❓ Frequently asked questions
What is the LTCG exemption on equity mutual funds?
In a financial year, the first ₹1.25 lakh of long-term gains from equity-oriented funds is completely tax-free; gains above that attract 12.5% LTCG tax. The exemption is on a financial-year basis — it applies once to the combined gains from all equity sales in the year.
How much tax if an equity fund is sold within 1 year?
20% STCG — raised from 15% in the 2024 Budget. The ₹1.25 lakh exemption does not apply here.
Do debt funds still get indexation benefit?
Not for debt funds bought after 1 April 2023 — gains are taxed at your income tax slab rate. However, after the 2024 Budget, units held for more than 24 months get long-term tax at 12.5% (without indexation). The old rules for funds bought before 2023 are grandfathered.
Is tax harvesting legal?
Yes, perfectly legal — the government itself has set the exemption limit. By selling up to ₹1.25 lakh of gains and reinvesting at the end of each financial year, you can use the exemption every year.