You’ve Checked the Returns - But Have You Checked the Taxes? (Part 2 - Making Smarter Choices)

Turning Tax Understanding into Smarter Choices

Some practical applications of the impact of tax on decision making:

 1.      Tax Loss and Gain Harvesting:

A temporary dip in portfolio value can be an opportunity. Tax-loss harvesting involves selling investments currently at a loss to offset capital gains from other holdings (or to carry forward the losses for future set-offs). This helps reduce overall taxable capital gains for the year, while allowing you to reinvest in similar/same assets to stay aligned with investment goals.

Tax-gain harvesting is the reverse - it means realizing long-term capital gains deliberately, when they fall within the tax-exempt threshold (for instance, up to ₹1.25 lakh in a financial year for equity shares and equity-oriented funds). This resets the purchase cost for future gains, helping manage future tax liability.

However, an investor needs to carefully consider the exit load on mutual funds while harvesting gains/losses. They also need to be careful that including this income does not result in their total income crossing the threshold for surcharge (as discussed above).

2.      Growth vs. IDCW:

While the decision of payout option (Growth vs. IDCW) is primarily guided by the investor’s need for regular income (or lack thereof), tax implications also matter in decision-making.

When a distribution is made under IDCW, 2 things happen – (i) A tax liability arises on the distribution, as discussed earlier; (ii) the NAV reduces to the extent of the distribution, implying lower capital gains in the future (when the investor redeems his units). In essence, choosing IDCW prepones the tax liability – from the time of redemption to the time of distribution.

Further, there could be a difference in the tax rate as well. Taking equity-oriented mutual funds as an example, IDCW distributions are taxed at the investor’s slab rate, whereas tax rate at redemption is 20% (short-term) or 12.5% (long term). Apart from the timing of taxation, the investor’s tax bracket can influence which option is more efficient. If the investor’s tax slab is lower than the 20% or 12.5%, IDCW option may result in lower taxes than growth, and vice versa if the investor’s tax slab is higher.

3.      Exemption for Purchase of a House:

Section 54F of the Income Tax Act grants an exemption from tax on long term capital gains, if the proceeds are used to purchase a residential house. Thus, if you sell your mutual funds (classifed as 'long term' based on criteria discussed in the Part 1 of this series) to purchase a house, the gain on sale of mutual funds may be exempt.

The exemption is available only to individuals and HUFs, and involves multiple conditions, which are based on the following:

• Number of houses owned by the individual

• Timing of purchase or construction of the house

• Restriction on additional houses that can be purchased or constructed within the next 1 and 3 years respectively

• Pro-rata exemption if the entire sales proceeds are not utilized for purchase/construction of the house

• Restriction on sale of the purchased house for 3 years

• Restriction on the purchase price of house (Rs. 10 crores), beyond which deduction would be restricted

Please note that we have not listed down all the conditions around the exemption. Further, each of these conditions are very nuanced and have specific rules/guidelines surronding them -so please consult your tax advisor before decision making.

Thus, if you are allocating a part of your mutual fund investments or SIPs towards your long term goal of purchasing a house, you can avail this exemption and retain most of your underlying returns.

This also ties-back to the concept of tax-gain harvesting - since the funds earmarked for purchase of house would anyway be exempt at the time of redemption, an investor can focus/prioritize gain harvesting on the portion not earmarked for purchase of a house.

Note: Please note that the tax provisions mentioned above are based on the prevailing law as of November 2025 for resident Indian individuals and assumes the investments will be sold after 1 April 2025. Tax provisions are open to interpretation so please consult your tax advisor before any decision making.