LTCG on Mutual Funds 2026: 12.5% Tax, ₹1.25 Lakh Exemption

How Is LTCG on Mutual Funds Taxed in 2026?

**Quick Answer:** Long-term capital gains on equity mutual funds held for more than 12 months are taxed at 12.5% on gains above ₹1.25 lakh in a financial year, under rules effective 23 July 2024. Short-term gains face 20%. A 4% health and education cess applies on the tax. Debt-fund units bought after 1 April 2023 are taxed at your slab rate. Most investors watch their returns obsessively and spare barely a thought for the tax bill waiting at redemption. For equity mutual funds, the bill follows a clean, fixed formula in 2026 — built on three numbers: the 12.5% rate, the ₹1.25 lakh annual exemption, and the 12-month holding clock.

The 12.5% rule, in one paragraph

Budget 2024, presented on 23 July 2024, overhauled capital-gains taxation through the Finance (No. 2) Act, 2024. For listed equity shares and equity-oriented mutual funds, it raised the long-term capital gains (LTCG) rate from 10% to 12.5%, raised the annual exemption from ₹1 lakh to ₹1.25 lakh, and raised the short-term capital gains (STCG) rate from 15% to 20%. These rules apply to transfers made on or after 23 July 2024. Neither Budget 2025 nor Budget 2026 reversed the regime, so the July-2024 rules are the ones you file under in 2026.

Which funds get the 12.5% treatment?

The concessional rate is reserved for "equity-oriented" funds — broadly, funds that invest more than 65% of their proceeds in equity shares of domestic companies. This is the line Section 112A of the Income-tax Act draws. In practice it covers: - Plain equity funds (large-cap, mid-cap, small-cap, flexi-cap, multi-cap, thematic) - Equity ETFs and index funds - Aggressive hybrid funds and arbitrage funds, provided they maintain the 65% equity threshold Conservative hybrid funds, which hold most of their corpus in debt, do not qualify — their units follow the debt-fund rules below. The scheme factsheet's stated equity allocation is the practical check. The holding period is 12 months. Units sold after being held for more than 12 months are long-term; units sold within 12 months are short-term.

The ₹1.25 lakh exemption: how it actually works

Each financial year, the first ₹1.25 lakh of your combined LTCG from equity shares and equity-oriented mutual funds is tax-free. A few points investors often miss: - The exemption is per financial year, not per fund. Gains from all your equity shares and equity mutual funds are added together, and the ₹1.25 lakh is subtracted once from the total. - It applies only to LTCG under Section 112A. Short-term gains get no such exemption. - Gains up to the exemption are simply ignored — if your total equity LTCG for the year is ₹1.25 lakh or less, you owe zero LTCG tax.

Worked example 1: a simple lump-sum redemption

Suppose you invested ₹1,00,000 in an equity fund and redeemed it two years later for ₹2,60,000. - LTCG = ₹2,60,000 − ₹1,00,000 = ₹1,60,000 - Less annual exemption = ₹1,60,000 − ₹1,25,000 = ₹35,000 taxable - Tax at 12.5% = ₹35,000 × 0.125 = ₹4,375 - Plus 4% health and education cess = ₹4,375 × 0.04 = ₹175 - **Total tax payable = ₹4,550** On a ₹1.6 lakh gain, the effective tax works out to under 3%.

STCG at 20%: the contrast that rewards patience

Sell the same units within 12 months and the gain is short-term: taxed at a flat 20% under Section 111A (plus 4% cess), with no ₹1.25 lakh exemption. On the example above, an identical ₹1,60,000 gain held for 11 months would attract ₹32,000 in tax plus ₹1,280 cess — ₹33,280 in total, versus ₹4,550 after 12 months.

SIPs: every instalment has its own clock

This is the detail that trips up most SIP investors. Each monthly instalment is treated as a separate investment, and the 12-month clock starts separately for each one. When you redeem, units are deemed sold on a first-in, first-out (FIFO) basis — the oldest instalments go first. Illustration: you invest ₹10,000 a month for 36 months and then redeem everything in one go. The instalments from the first two years are older than 12 months, so their gains qualify for the 12.5% LTCG treatment (after the shared ₹1.25 lakh exemption). The instalments from the last 12 months are still short-term, so their gains face 20%. Your capital-gains statement from the fund house or registrar breaks this down instalment by instalment.

ELSS: the 3-year lock-in makes LTCG the norm

Equity-linked savings schemes (ELSS) carry a mandatory 3-year lock-in on every instalment — you simply cannot redeem before three years. Since three years comfortably exceeds the 12-month threshold, ELSS redemptions are almost always long-term gains, taxed at 12.5% above the ₹1.25 lakh annual exemption.

What about debt and hybrid funds?

The rules split by purchase date, and this is where investors get caught: - **Units bought after 1 April 2023** in "specified" (mainly debt-oriented) funds: gains are always taxed at your income-tax slab rate, regardless of how long you held them. No indexation benefit, no 12.5% option. From April 2025, "specified" broadly means funds with more than 65% in debt and money-market instruments. - **Units bought before 1 April 2023** and redeemed on or after 23 July 2024: LTCG after a 24-month holding period is taxed at 12.5% without indexation; shorter holdings are taxed at slab rates. So a debt-fund investor who bought in 2024 and sells in 2026 pays slab-rate tax on the entire gain — a very different outcome from the 12.5% equity treatment.

Tax-loss harvesting: the concept, with an illustration

"Tax-loss harvesting" is a term you will hear around March. The concept is simple: capital losses can be set off against capital gains of the same year, which reduces the taxable gain. Long-term losses can generally only offset long-term gains; short-term losses can offset both short- and long-term gains. Unused losses can typically be carried forward for up to eight years if the return is filed on time. Here is a purely illustrative example of how the arithmetic works — not a suggestion to buy or sell anything: - Fund A sold with LTCG of ₹2,00,000; Fund B sold with a long-term loss of ₹60,000 - Net LTCG = ₹2,00,000 − ₹60,000 = ₹1,40,000 - Less ₹1,25,000 exemption = ₹15,000 taxable - Tax = ₹15,000 × 12.5% = ₹1,875; + 4% cess = ₹75 → **₹1,950 total** - Without the loss offset: ₹75,000 taxable → ₹9,375 + ₹375 cess = **₹9,750** - Difference: ₹7,800 less tax in this illustration One approach investors discuss with their tax advisers is reviewing unrealised losses before year-end. But harvesting involves real sales with real consequences — exit loads, market timing, and the risk of selling a fund that still fits your plan. Treat it as a concept to understand; any action belongs in a conversation with a qualified adviser.

Grandfathered gains: the 31 January 2018 line

If you have held equity fund units since before February 2018, there is one more protection. When LTCG on equity became taxable in Budget 2018, gains accrued up to 31 January 2018 were "grandfathered" — protected from the new tax. Your cost of acquisition for such old holdings is taken as the higher of your actual purchase price or the lower of (the fund's NAV on 31 January 2018) and (your sale price). In plain terms: appreciation up to that January date stays tax-free; only the growth after it is taxed.

The fine print: cess, surcharge, TDS, and reporting

- **Cess:** add 4% health and education cess on the computed tax (and on any surcharge). - **Surcharge:** high-income investors (total income above ₹50 lakh) face an additional surcharge on the tax. - **TDS:** no tax is deducted at source when a resident individual redeems mutual fund units — the full redemption amount is credited and you pay the tax when filing. (NRIs are different: tax is deducted on their redemptions. And TDS does apply to mutual-fund dividends above ₹5,000 a year.) - **Reporting:** equity LTCG is reported scrip-wise in Schedule 112A, within Schedule CG of the income-tax return — typically ITR-2 for individuals without business income. Your fund house or registrar's capital-gains statement is the document to file from. - **Switches count as sales:** moving from one scheme to another — even within the same fund house — is a redemption followed by a purchase. The gain on the switch is taxable in that year.

This article is for educational purposes only and is not financial advice. Please consult a SEBI-registered investment adviser for personalized guidance. Investments are subject to market risk.