Understanding the tax implications of selling or switching mutual funds (2024)

FAQs

Understanding the tax implications of selling or switching mutual funds? ›

Here is what you need to know: If you sell a mutual fund investment and the proceeds exceed your adjusted cost base, you realize a capital gain. Realized capital gains must be reported for tax purposes in the year of sale. Capital gains are also taxed more favourably than interest, dividend and foreign income.

If you switch from an equity fund before one year, you will have to pay short-term capital gains tax at 15%. If you switch after one year, you will have to pay long-term capital gains tax at 10% on the gains exceeding Rs. 1 lakh in a financial year.

If you move between mutual funds at the same company, it may not feel like you received your money back and then reinvested it; however, the transactions are treated like any other sales and purchases, and so you must report them and pay taxes on any gains.

Short-term capital gains (assets held 12 months or less) are taxed at your ordinary income tax rate, whereas long-term capital gains (assets held for more than 12 months) are currently subject to federal capital gains tax at a rate of up to 20%.

They may also exchange from one fund into any other fund in the fund family. In doing so they exchange their total shares for the same number of shares in another fund. Investors should be aware that this could result in a tax burden if a capital gain occurs.

Adjusted Cost Base

If the units you sold are worth less than what you originally paid, the switch will generate a capital loss. When switching between funds, keep in mind that you are required to keep track of your capital gain and include its taxable portion in your taxable income in the year of sale.

No, there is no penalty for switching between funds. However, fund houses can levy an exit load if you switch before a specific time period. Moreover, the gains you have earned so far are subject to capital gains tax.

Just as with individual securities, when you sell shares of a mutual fund or ETF (exchange-traded fund) for a profit, you'll owe taxes on that "realized gain." But you may also owe taxes if the fund realizes a gain by selling a security for more than the original purchase price—even if you haven't sold any shares.

A mutual fund exchange occurs when you sell mutual fund assets to purchase mutual fund assets in the same mutual fund family. A mutual fund cross family trade occurs when you sell mutual fund assets in one mutual fund family to purchase mutual fund assets in a different mutual fund family.

To calculate capital gains from mutual funds, you need to subtract the purchase cost (or indexed purchase cost where applicable) from the sale or redemption value.

How to avoid mutual fund capital gains distributions? ›

The best way to avoid the capital gains distributions associated with mutual funds is to invest in exchange-traded-funds (ETFs) instead. ETFs are structured in a way that allows for more efficient tax management.

Capital gains generated by funds held in a taxable account will result in taxable capital gains, even if you reinvest your capital gains back into the fund. Thus, it may be smart not to reinvest the capital gains in a taxable account so that you have the cash to pay the taxes due.

The longer the investor has to delay their purchase, the greater this risk becomes. Some investors also may consider selling fund shares before a distribution to avoid the tax due. If the investor had gains on the shares at the time of the sale, the realized gains would be taxable in the year the shares were sold.

To answer your question directly, an exchange between mutual funds would generate a taxable event in a non-retirement brokerage account. In non-retirement accounts, your tax liability is generally the amount of the gain on the fund being exchanged.

Even if the new scheme is from the same fund house, the investor has to pay the capital gains tax. Switching funds is considered as redemption as we are exiting the original investment. The tax amount depends on the type of fund - if the old scheme was an equity fund or a non-equity fund.

Systematic Withdrawal Plan (SWP): Set up an SWP to automatically redeem your mutual fund units regularly. By keeping withdrawals below Rs. 1 lakh per year, you may avoid LTCG tax altogether.

Most investors hold their mutual funds in accounts at brokerage firms (whether tax-deferred retirement accounts or taxable accounts) or in 401(k) retirement plans. In these cases, investors don't have to pay extra taxes when a mutual fund they own converts to an ETF.