Taxation of Earnings from the Sale of Units of Mutual Funds – AY 2026-27

 

A Complete Guide to Capital Gains Tax on Mutual Funds and Applicable ITR Forms

Mutual funds have become one of the most popular investment options for individuals seeking long-term wealth creation. While investing in mutual funds offers several financial benefits, it is equally important to understand the tax implications when you sell or redeem your units.

The taxation of mutual funds depends on the type of mutual fund, the holding period, and the date of investment. Incorrect reporting of capital gains may lead to notices from the Income Tax Department. Therefore, every taxpayer should understand the applicable tax provisions before filing the Income Tax Return (ITR).

This article explains the latest taxation rules applicable for Assessment Year (AY) 2026-27.

What is Taxable When You Sell Mutual Fund Units?

Whenever an investor redeems, switches, or sells units of a mutual fund, the profit earned is treated as Capital Gain.

The capital gain is calculated as follows:

Capital Gain = Sale Value – Cost of Acquisition – Transfer Expenses (if any)

Depending on the holding period, capital gains are classified into:

• Short-Term Capital Gain (STCG)
• Long-Term Capital Gain (LTCG)

Types of Mutual Funds

For income tax purposes, mutual funds are generally classified into the following categories:

• Equity Mutual Funds
• Debt Mutual Funds
• Hybrid Mutual Funds
• Gold Mutual Funds
• International Mutual Funds
• Fund of Funds (FoFs)

Each category is taxed differently under the Income-tax Act.

Taxation of Equity Mutual Funds

An Equity Mutual Fund is one that invests at least 65% of its total assets in equity shares of domestic companies.

Holding Period

Holding Period	Nature of Gain
Up to 12 Months	Short-Term Capital Gain
More than 12 Months	Long-Term Capital Gain

Short-Term Capital Gain (STCG)

If equity mutual fund units are sold within 12 months, the gain is taxable under Section 111A.

Tax Rate: 20% (plus applicable surcharge and cess)

Long-Term Capital Gain (LTCG)

If units are held for more than 12 months, the gain is taxable under Section 112A.

• Tax Rate: 12.5%
• Exemption: ₹1,25,000 in a financial year
• Tax is payable only on LTCG exceeding ₹1,25,000.

Example

Purchase Price: ₹5,00,000

Sale Price: ₹8,50,000

Long-Term Capital Gain: ₹3,50,000

Less: Exemption: ₹1,25,000

Taxable LTCG: ₹2,25,000

Income Tax @12.5% = ₹28,125

Taxation of Debt Mutual Funds

The taxation of debt mutual funds has undergone significant changes.

For specified debt mutual funds acquired on or after 1 April 2023, the benefit of long-term capital gains and indexation is no longer available.

The gain is generally taxed as Short-Term Capital Gain, irrespective of the holding period.

The income is taxable according to the investor's applicable income tax slab rate under Section 50AA.

Example

Purchase Price: ₹4,00,000

Sale Price: ₹4,80,000

Capital Gain: ₹80,000

If the investor falls under the 30% tax slab,

Income Tax = ₹24,000 plus applicable cess.

Taxation of Hybrid Mutual Funds

Hybrid mutual funds invest in both equity and debt instruments.

Their taxation depends upon the percentage of equity investment.

• If equity exposure is 65% or more, taxation is similar to equity mutual funds.
• If equity exposure is less than 65%, the applicable provisions for non-equity/specified mutual funds apply.

Taxation of Gold and International Mutual Funds

Gold mutual funds and international mutual funds are generally treated as non-equity mutual funds.

For many such investments acquired on or after 1 April 2023, capital gains are taxable according to the investor's normal income tax slab under Section 50AA.

Investors should always verify the tax category of the specific scheme before filing their return.

Securities Transaction Tax (STT)

STT is applicable on redemption of equity-oriented mutual fund units.

However, STT is not allowed as a deduction while calculating capital gains.

Set-off and Carry Forward of Capital Losses

The Income-tax Act permits adjustment of capital losses subject to certain conditions.

Short-Term Capital Loss (STCL)

Short-term capital loss can be adjusted against:

• Short-Term Capital Gain
• Long-Term Capital Gain

Long-Term Capital Loss (LTCL)

Long-term capital loss can be adjusted only against Long-Term Capital Gain.

Unabsorbed capital losses can be carried forward for eight assessment years, provided the Income Tax Return is filed within the prescribed due date.

Taxability of Dividend from Mutual Funds

Dividend received from mutual funds is taxable in the hands of the investor.

It is taxable under the head "Income from Other Sources" and is charged according to the applicable income tax slab.

Which ITR Form Should Be Filed?

Choosing the correct Income Tax Return (ITR) form is equally important.

ITR-1 (Sahaj)

ITR-1 can be filed by an eligible resident individual having:

• Salary or Pension Income
• Income from One House Property
• Other Sources
• Eligible Long-Term Capital Gain under Section 112A up to ₹1,25,000, subject to the prescribed conditions.

ITR-2

ITR-2 should be filed where the taxpayer has:

• Salary or Pension Income
• Capital Gains from Mutual Funds
• No Business or Professional Income

Most investors earning capital gains from mutual funds are required to file ITR-2.

ITR-3

ITR-3 is applicable where the taxpayer has:

• Business Income
• Professional Income
• Capital Gains from Mutual Funds

For example, Chartered Accountants, doctors, consultants, traders, and other professionals earning capital gains generally file ITR-3.

ITR-4

Taxpayers opting for the Presumptive Taxation Scheme may file ITR-4 only if they satisfy all the prescribed conditions. If the capital gains fall outside the scope permitted under ITR-4, the taxpayer may have to file ITR-3 instead.

Documents Required While Filing ITR

Before filing your return, keep the following documents ready:

• Capital Gain Statement issued by the Mutual Fund or Registrar
• Consolidated Account Statement (CAS)
• Annual Information Statement (AIS)
• Form 26AS
• PAN Card
• Bank Account Details
• Purchase and Redemption Statements

Conclusion

The taxation of mutual funds has changed considerably over the past few years. Investors should understand the tax treatment applicable to different categories of mutual funds before redeeming their investments.

Equity-oriented mutual funds continue to enjoy concessional tax rates on long-term capital gains, whereas many debt-oriented and specified mutual funds are now taxed according to the investor's income tax slab.

Selecting the correct ITR form and accurately reporting capital gains ensures compliance with the Income-tax Act and helps avoid unnecessary notices from the Income Tax Department.

If you have earned income from the sale of mutual fund units and need assistance in calculating capital gains or filing your Income Tax Return, consult a qualified Chartered Accountant for professional guidance.

Frequently Asked Questions (FAQs)

1. Is profit from mutual funds taxable?

Yes. Profit earned on the sale or redemption of mutual fund units is taxable as capital gains.

2. Which ITR should I file for mutual fund capital gains?

Generally, ITR-2 is applicable if you have no business or professional income. If you have business or professional income, ITR-3 is generally required.

3. What is the tax rate on equity mutual funds?

Short-Term Capital Gains are taxed at 20%, while Long-Term Capital Gains exceeding ₹1,25,000 are taxed at 12.5%.

4. Are debt mutual funds taxed differently?

Yes. Many specified debt mutual funds acquired on or after 1 April 2023 are taxed according to the investor's normal income tax slab.

5. Is dividend from mutual funds tax-free?

No. Dividend received from mutual funds is taxable under the head Income from Other Sources according to the applicable income tax slab.