Capital Gains from Mutual Funds? Know When to Use ITR 2 vs ITR 1

Capital gains from mutual funds in India are classified into short-term capital gains (STCG) and long-term capital gains (LTCG), with tax rates differing based on the type of fund and the holding period. Equity funds, debt funds, and hybrid funds each have distinct tax treatments. For instance, STCG from equity funds is taxed at 15% if held for less than 36 months, while LTCG exceeding ₹1 lakh is taxed at 10%. For debt and hybrid funds, STCG is taxed as per the individual's income tax slab, and LTCG is taxed at 20% after applying indexation benefits.

Filing the correct Income Tax Return (ITR) form is crucial for mutual fund investors. If your total income is below ₹50 lakh and you have no other sources of income, you can use ITR 1, provided your LTCG is below ₹1.25 lakh. However, if your capital gains exceed ₹1.25 lakh or your income includes other sources, ITR 2 is required.

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Table of Contents

• Capital Gains from Mutual Funds: A Quick Overview

• Tax Rates for Mutual Fund Capital Gains

• When to Use ITR 1 vs ITR 2

• How TaxBuddy Simplifies ITR Filing for Capital Gains

• Conclusion

• FAQs

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Capital Gains from Mutual Funds

Capital gains from mutual funds arise when you sell your mutual fund units for a profit. These gains are categorized as either short-term or long-term, depending on the holding period of the mutual fund units. For equity-oriented mutual funds, if the units are sold within three years of purchase, the gains are considered short-term; otherwise, they are considered long-term. Debt and hybrid funds, on the other hand, have a longer holding period to qualify for long-term treatment. The tax on capital gains is calculated based on whether the gains are short-term or long-term, with different tax rates applied. It's crucial for investors to understand the nuances of reporting these gains in the right ITR form—ITR 1 for simpler cases and ITR 2 for more complex situations, especially when dealing with higher amounts of capital gains or a mix of income sources.

Tax Rates for Mutual Fund Capital Gains

Capital gains from mutual funds in India are taxed based on the type of fund, the holding period, and whether the gains are short-term or long-term. Here’s a detailed look at how different types of mutual funds are taxed:

Equity-Oriented Funds (EOFs)

• Short-Term Capital Gains (STCG): If the investment in an equity-oriented mutual fund is sold within 36 months, the gains are classified as short-term. These gains are taxed at a flat rate of 15%. This is applicable to investments in equity mutual funds, equity ETFs, and stocks that are held for less than 36 months.
  

• Long-Term Capital Gains (LTCG): For equity-oriented funds, any gains exceeding ₹1 lakh in a financial year are considered long-term. These gains are taxed at 10% without the benefit of indexation. This change was introduced to make long-term investments in equity mutual funds more attractive, though it still ensures that large capital gains are taxed to some extent.

Debt Funds and Hybrid Funds

• Short-Term Capital Gains (STCG): If the debt or hybrid fund investment is sold within 36 months, the gains are classified as short-term. STCG from debt funds is taxed according to the individual’s income tax slab rate, i.e., the gains are added to the total taxable income and taxed at the applicable rate.
  

• Long-Term Capital Gains (LTCG): If the debt or hybrid fund investment is held for more than 36 months, the gains are classified as long-term. These gains are taxed at 20% after allowing for indexation benefits, which helps account for inflation over the holding period.

Tax Rates for Mutual Fund Capital Gains

Capital gains from mutual funds in India are divided into two categories: short-term capital gains (STCG) and long-term capital gains (LTCG). The tax treatment of these gains depends on the holding period of the mutual fund units and the type of fund in which you have invested. Understanding the tax rates applicable to different mutual funds can help you manage your tax liabilities effectively.

Equity-Oriented Funds (EOFs)

• Short-Term Capital Gains (STCG): For equity-oriented funds, STCG is applicable when units are sold within 36 months of investment. The tax rate on STCG is a flat 15%, which applies to all gains realized within this period. This tax is applicable for investments in equity mutual funds, equity exchange-traded funds (ETFs), and stocks.
  

• Long-Term Capital Gains (LTCG): When you hold your equity fund investments for more than 36 months, the gains are classified as long-term. If the LTCG exceeds ₹1 lakh in a financial year, it is subject to a 10% tax rate without the benefit of indexation. However, if the LTCG is below ₹1 lakh, no tax is levied on such gains.

Debt Funds and Hybrid Funds

• Short-Term Capital Gains (STCG): In case of debt and hybrid funds, if the investment is sold within 36 months, the gains are categorized as short-term. These gains are taxed at the individual’s applicable income tax slab rate, which means they are added to the total taxable income and taxed accordingly.
  

• Long-Term Capital Gains (LTCG): If the debt or hybrid fund investment is held for more than 36 months, the gains qualify as long-term. The LTCG tax rate for these funds is 20%, with the benefit of indexation. Indexation helps to adjust the purchase cost for inflation, reducing the taxable gain.

When to Use ITR 1 vs ITR 2

Choosing the correct Income Tax Return (ITR) form is critical for accurate tax filing, especially for mutual fund investors. The form you select depends on your total income and the sources of your capital gains. Here’s when to use ITR 1 and ITR 2.

ITR 1 for Mutual Fund Investors

ITR 1, also known as the "Sahaj" form, is a simplified form for individuals whose income is less than ₹50 lakh. It is applicable to individuals who earn income from:

• Salary or pension

• One house property

• Other sources like interest income, etc.

• Short-Term Capital Gains (STCG) from mutual funds, provided the total income does not exceed ₹50 lakh.

However, ITR 1 is not applicable if

• The taxpayer has Long-Term Capital Gains (LTCG) from mutual funds exceeding ₹1.25 lakh.

• The taxpayer has income from multiple sources like foreign assets, more than one house property, or income from unlisted shares.

ITR 2 for Mutual Fund Investors

If your total income exceeds ₹50 lakh or includes significant capital gains, then ITR 2 should be used. This form is required when:

• You have LTCG from mutual funds that exceed ₹1.25 lakh in a year.

• You have capital gains from both equity and debt funds.

• Your income comes from multiple sources, such as foreign assets, business profits, or more than one house property.

ITR 2 is more comprehensive and allows for detailed reporting, making it necessary for individuals who exceed the thresholds set for ITR 1 or have complex income sources.

Filing Process for Capital Gains

Filing taxes for capital gains from mutual funds involves specific steps to ensure accuracy and compliance. The following steps outline how to report capital gains on your ITR:

How to Report Capital Gains in ITR

• Short-Term Capital Gains (STCG): STCG should be reported in Schedule CG of your ITR form, specifically in the section for "Short-Term Capital Gains."
  

• Long-Term Capital Gains (LTCG): For LTCG from equity funds, report the gains in Schedule 112A. If your gains exceed ₹1 lakh, ensure proper reporting in the designated sections of ITR 2.

Adjusting for Losses

• STCG Losses: STCG losses can be offset against other short-term capital gains or long-term capital gains within the same financial year, helping to reduce your tax liability.
  

• LTCG Losses: LTCG losses can only be offset against other long-term capital gains. Any unutilized LTCG losses can be carried forward to offset future long-term capital gains for up to 8 years.

Exemptions and Tax-Free Transfers

Certain transactions, such as mutual fund consolidations, are exempt from taxes. Additionally, gains below the basic exemption limit (₹3 lakh for FY 2025-26) are also tax-free. If you meet these criteria, you may not need to pay any tax on your capital gains.

How TaxBuddy Simplifies ITR Filing for Capital Gains

TaxBuddy makes filing your Income Tax Return for capital gains simple and accurate. With its user-friendly platform, TaxBuddy ensures that:

• Capital Gains are Automatically Imported: TaxBuddy pulls data directly from your mutual fund transactions, saving time and reducing the chances of error.
  

• Real-Time Tax Calculations: The platform instantly calculates your STCG and LTCG based on the mutual fund data provided, helping you understand how much tax you owe.
  

• Instant Error Checks: TaxBuddy reviews your ITR before submission, ensuring that all capital gains are correctly reported and no deductions are missed.
  

• Tax Planning: TaxBuddy also provides tips on tax-saving strategies, helping you optimize your mutual fund investments for the best tax outcomes.

Conclusion

For anyone looking for assistance in tax filing, it is highly recommended todownload the TaxBuddy mobile app for a simplified, secure, and hassle-free experience. TaxBuddy's intuitive features and automated tools make managing capital gains from mutual funds and filing ITR a seamless process.

Frequently Asked Question (FAQs)

Q. Does TaxBuddy offer both self-filing and expert-assisted plans for ITR filing, or only expert-assisted options? Yes, TaxBuddy offers both self-filing and expert-assisted plans, giving users flexibility based on their comfort level and filing needs. With the self-filing option, users can easily navigate through the tax filing process using automated tools provided by the platform. For those who prefer expert guidance, TaxBuddy also offers expert-assisted plans where tax professionals handle the entire filing process, ensuring compliance with the latest regulations. This makes it ideal for both tax-savvy individuals and those seeking professional assistance.

Q. Which is the best site to file ITR? TaxBuddy is one of the best platforms for filing Income Tax Returns (ITR). It provides a seamless, user-friendly experience with automated features that simplify the entire tax filing process. TaxBuddy is specifically designed to cater to various types of income, including capital gains from mutual funds. Its real-time tax calculations, automatic data import from investment platforms, and built-in error checks make it an excellent choice for anyone looking to file their ITR efficiently and accurately.

Q. Where to file an income tax return?

You can file your Income Tax Return (ITR) through the official Income Tax Department portal (incometax.gov.in), but platforms like TaxBuddy offer a more streamlined, secure, and hassle-free alternative. TaxBuddy simplifies the process by offering easy-to-follow steps, automated tools for mutual fund capital gains, and real-time tax calculations, ensuring that you meet all compliance requirements without confusion.

Q. Can I use ITR-1 if I have both salary and LTCG from mutual funds?

Yes, you can use ITR-1 if your Long-Term Capital Gains (LTCG) from mutual funds do not exceed ₹1.25 lakh and your total income is less than ₹50 lakh. ITR-1 is designed for individuals who have income from salary, pension, one house property, and other sources like interest income. However, if your LTCG exceeds ₹1.25 lakh, or if you have income from sources like foreign assets or more than one house property, you will need to file using ITR-2.

Q. How are SIP redemptions taxed?

Systematic Investment Plan (SIP) redemptions are taxed based on the holding period of each individual installment. Each SIP installment is treated as a separate transaction. If the SIP is redeemed within 12 months of investment, the gains are subject to Short-Term Capital Gains (STCG) tax at the rate of 15%. If the units are redeemed after 12 months, the gains are classified as Long-Term Capital Gains (LTCG) and taxed at 10% for equity mutual funds (if gains exceed ₹1 lakh).

Q. Are dividends from mutual funds taxable?

Yes, dividends from mutual funds are taxable in the hands of the investor. If the dividend income exceeds ₹5,000 in a financial year, a Tax Deducted at Source (TDS) of 10% is levied on the dividend payout. The dividend income must be reported under "Income from Other Sources" in the ITR. Even if TDS is deducted, you are still required to report the total dividend income received during the financial year.

Q. Does switching between fund plans trigger capital gains?

Yes, switching between different plans within the same mutual fund (such as from growth to dividend or vice versa) triggers a taxable event. The redemption of units from the original plan is treated as a sale, and the gains made on the transaction are subject to capital gains tax. The tax treatment (STCG or LTCG) depends on how long the units were held before the switch.

Q. How do post-July 2024 tax changes affect filings?

Post-July 2024, the tax rate on Long-Term Capital Gains (LTCG) from equity mutual funds will rise to 12.5% for gains exceeding ₹1 lakh in a financial year. This change in tax rate will impact ITR-2 filings as investors will need to account for the updated tax rates while reporting their capital gains from equity mutual funds. It’s important to update tax calculations accordingly to ensure accurate filings.

Q. Can I offset my capital gains with losses?

Yes, you can offset Short-Term Capital Gains (STCG) with other STCG or Long-Term Capital Gains (LTCG) within the same financial year. Similarly, LTCG losses can only be offset against other LTCG. If you have more capital gains than losses, the balance loss can be carried forward to the next eight years, which can be used to offset future gains and reduce your tax liability.

Q. What are the exemptions available for capital gains?

Certain transactions involving mutual funds are exempt from taxes. For instance, mutual fund consolidations (when one fund consolidates with another) do not attract any capital gains tax. Additionally, gains below the basic exemption limit (₹3 lakh for FY 2025-26) are also exempt from tax. If your total capital gains fall below this threshold, you may not need to pay tax on the gains.

Q. Can TaxBuddy help with mutual fund tax filing?

Yes, TaxBuddy is specifically designed to assist with mutual fund tax filings. It simplifies the entire process by automatically importing data related to your mutual fund investments, calculating your capital gains, and ensuring accurate tax reporting. This eliminates the need for manual calculations and minimizes the chances of errors. With TaxBuddy, you can file your returns with confidence, knowing that all mutual fund-related tax obligations are correctly handled.

Q. How does TaxBuddy help with loss adjustments?

TaxBuddy offers smart features that help you offset STCG and LTCG losses against any applicable gains. The platform ensures that your capital gains and losses are properly accounted for, helping you optimize your tax liability. By tracking losses and gains across different investments, TaxBuddy enables you to make adjustments in your tax filings, reducing the tax burden and ensuring compliance with the latest tax regulations.