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

FAQs

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

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.

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.

Switching between mutual funds is a taxable event, as it is considered as a redemption and a fresh investment. The tax liability depends on the type and duration of the fund that you switch from and to.

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%.

Switching between mutual funds

If the units you sold are worth more than your ACB, the switch will generate a capital gain . If the units you sold are worth less than your ACB, the switch will generate a capital loss .

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.

The only way to avoid receiving, and paying taxes on, a fund's capital gain distribution is to sell the entire position before the record date.

You will get several benefits when you switch to a mutual fund. When your goals are altered or attained, that is the first sign. Take your money out, for example, if you have been investing for a long time, perhaps for retirement or upgrading your car.

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.

How do I avoid tax on mutual funds? ›

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.

Mutual funds are not taxed twice. However, some investors may mistakenly pay taxes twice on some distributions. For example, if a mutual fund reinvests dividends into the fund, an investor still needs to pay taxes on those dividends.

However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.

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.

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.

The conversion is a non-taxable event. 1 In addition, the share class expense ratio is often lower for Class A shares, which is an added benefit for the shareholder. Funds within a fund family may be reclassified due to exchange privileges.

If the ETFs were held for less than 1 year, the profits are considered to be short-term capital gains. Such gains are taxed at 15% u/s 111A of the Income Tax Act, 1961. However, if you have held the ETFs for longer than 1 year, the profits will be classified as long-term capital gains.

The conversion is a non-taxable event. 1 In addition, the share class expense ratio is often lower for Class A shares, which is an added benefit for the shareholder. Funds within a fund family may be reclassified due to exchange privileges.

Please note that when you convert your current asset base into an ETF you do not ELIMINATE taxes, you simply carry over your basis from your underlying investments, and your old basis is now the basis in your ETF shares.