How to Save from Paying Long-Term Capital Gains Tax in Mutual Funds

Greetings! Understanding the tax implications of your investment in mutual funds is crucial to maximizing your returns. Let’s first dive into how much Long-Term Capital Gains (LTCG) tax you may owe and explore strategies to reduce your tax liability.

Understanding Long-Term Capital Gains Tax

When you sell a mutual fund after a holding period of more than 12 months, the tax on your gains differs based on the type of mutual fund you invest in. Mutual funds are broadly categorized into two types:

Equity-Oriented Funds: These schemes invest at least 65% of your money in Indian stocks. Non-Equity Funds: These schemes invest less than 65% of your money in stocks.

Tax Strategy in Equity-Oriented Mutual Funds

For equity-oriented funds, if your holding period exceeds 12 months, you only pay 10% tax on gains exceeding the Rs. 1 lakh threshold. This strategy is known as tax harvesting.

To illustrate this, let’s consider an example. Suppose you have invested Rs. 6 lakh in an equity mutual fund on 14th Feb 2021. On 19th Feb 2022, the value of this investment has grown to Rs. 6.9 lakh. By redeeming this investment, you would achieve a gain of Rs. 90,000 with a tax liability of zero. This is because any equity investment held for more than 12 months qualifies for long-term capital gains, and the tax is only payable on gains exceeding Rs. 1 lakh in a financial year.

Subsequently, you should reinvest the entire Rs. 6.9 lakh to reset your investment cost and date. If in the next year, the investment grows to Rs. 7.8 lakh, you would again redeem your investment to keep your gains at Rs. 90,000, which is still below the threshold of Rs. 1 lakh.

Had you not redeemed and reinvested your long-term gains, it would have been Rs. 80,000 (Rs. 7.8 lakh - Rs. 6 lakh), and you would have had to pay 10% tax on this amount, i.e., Rs. 8,000.

Tax Loss Harvesting

While tax harvesting is a strategy to leverage gains, tax loss harvesting is another technique that can save you tax. In this strategy, you book losses and offset gains in any other instrument to reduce your tax liability.

For instance, consider an investment of Rs. 4 lakh in an equity fund on 15th January 2020. After more than a year, on 22nd January 2021, the investment value drops to Rs. 3.8 lakh. Here, your long-term capital loss is Rs. 20,000. If you sell the investment, you are booking the losses. You can use this loss to reduce any long-term capital gains you may have realized in the same year. If the losses cannot be used in the same year, they can be carried forward for up to 8 assessment years.

To understand this further, assume you sell another long-term equity mutual fund investment two years later and make Rs. 1.5 lakh in capital gains. You are Rs. 50,000 above the Rs. 1 lakh limit, so you have to pay tax. However, you can offset this with the Rs. 20,000 loss, reducing your effective long-term capital gains to Rs. 1.3 lakh and reducing your tax liability.

Conclusion

Both tax gain and tax loss harvesting can be used to reduce the taxes you pay on your long-term capital gains from equity investments. It is essential to reinvest the money once you receive the redemption amount. Failing to do so would break your compounding journey.

Final Thoughts

Both strategies can help you manage your tax efficiently. By understanding these methods, you can make informed investment decisions that maximize your returns. If you learned something new, please UPVOTE and SHARE our answer to help us reach more readers. For more insights on managing your investments and money better, follow our Quora space: All About Money.