How to save income tax while switching from equity funds to liquid funds?

Switching money from equity mutual funds to liquid funds often looks like a simple task. But many investors miss an important part of this move, the tax impact.

When you switch from equity funds to liquid funds, it is treated as a sale of your equity investment. This can trigger capital gains tax depending on how long the investment was held.

Understanding this before you shift your money can help you plan better and avoid unnecessary tax outgo.

You cannot completely avoid tax, but you can reduce it by planning the switch carefully.

"If you switch after holding your equity funds for more than one year. In this case, your gains are taxed as long-term capital gains, which are taxed at a lower rate. Also, gains up to ₹1.25 lakh in a financial year are tax-free, so you can plan your switch to make use of this limit," said CA Abhishek Soni, CEO & Co-founder Tax2win.

"Don't chase market tops for withdrawal, but begin transitioning equity investments to liquid funds 3-6 months before your goal, in 4-6 staggered instalments to average out volatility. Leverage the annual ₹ l.25 lakh LTCG exemption on each redemption to de-risk efficiently while minimising taxes," said CFP Shweta Shastri.

Instead of moving the entire amount at once, consider switching in parts over different financial years. "This helps you use the tax-free limit each year and reduces the total tax outflow," explained Abhishek Soni

You can also adjust your gains against any capital losses from other investments, which further lowers your taxable amount, added Soni.

What are equity funds?

What are liquid funds?