How Are Mutual Fund Gains Taxed?

What counts as a capital gain

When you redeem (sell) mutual fund units for more than you paid, the difference is a capital gain. If you sell for less, it is a capital loss. Nothing is taxed while the units are simply held and rising in value — the trigger is redemption, including a switch from one scheme to another, which is treated as a redemption and a fresh purchase.

Two questions decide the treatment

1. What kind of fund is it? Tax law distinguishes equity-oriented funds (those holding a specified minimum share of domestic equities) from other funds — debt, gold, international, many hybrids. The classification determines which set of rules applies.
2. How long were the units held? Gains are short-term if held below a threshold period and long-term above it. The threshold differs by classification, and the applicable rates differ between short- and long-term gains.

Both the thresholds and the rates have been changed by past Budgets. This is why we deliberately do not print them: check the current provisions on the Income Tax Department portal or the scheme information from AMFI before relying on a figure.

SIPs: every instalment is its own purchase

A SIP is a series of purchases, each with its own date and cost. When you redeem, units are matched first-in, first-out: the oldest units go first. So a redemption from a three-year-old SIP may contain units that are long-term (early instalments) and units that are still short-term (recent instalments), each taxed under its own rule. The year-by-year table in our SIP calculator shows how much of a corpus comes from each year's instalments — useful context for this.

Withdrawals through an SWP

A Systematic Withdrawal Plan is a series of small redemptions, so each withdrawal can create a small capital gain (or loss) computed on the units sold, again on a first-in, first-out basis. SWP income is therefore not 'tax-free income'; it is a stream of redemptions.

Dividends (IDCW) are different

Payouts from funds under the income-distribution option are not capital gains; they are added to your income and taxed at your slab, and may attract TDS above thresholds — see What is TDS? and how income tax calculation works.

Losses and set-off

Capital losses can generally be set off against capital gains under rules that specify which type may offset which, and unused losses may be carried forward for a limited number of years if the return is filed on time. The specifics are governed by current law.

Why this matters when comparing products

Headline returns ignore tax. An FD's interest is taxed every year at your slab (see how), whereas a mutual fund gain is taxed only when realised, under capital-gains rules. The honest comparison is on a post-tax, like-for-like basis — and it depends on your slab, your holding period and the rules of the year you redeem.