How capital gains tax on equity mutual funds is calculated using the FIFO method

Equity mutual fund investors realise capital gains when they sell their holdings at a price higher than their cost of acquisition. These capital gains are taxed based on the period of holding.

For instance, if you sell your units after holding them for 12 months, gains above ₹1.25 lakh are taxed as long-term capital gains (LTCG) at 12.5%. However, when you sell them before completing 12 months, gains are taxed at 20% as short-term capital gains (STCG).

The FIFO method is an important concept in taxation, especially when redeeming equity mutual fund units. It helps in determining both the cost of acquisition and the period of holding for calculating capital gains tax.

Under FIFO, mutual fund redemptions are matched against the oldest purchased units first. For example, suppose you bought 500 units of an equity scheme on April 1, 2024, and 500 more on May 1, 2024, then sold 400 units on April 1, 2025. In this case, the units sold would be considered part of the first 500 units purchased on April 1, 2024. How does it help? You may ask.

Well, investors generally acquire mutual fund units in multiple instalments over a period of time. Some even opt for a systematic investment plan (SIP) where they acquire units after fixed intervals. The holding period of units acquired in one lot is different from those acquired in another. As tax depends on the holding period, each lot of acquired units may be taxed at different rates, based on their holding period. Calculating tax for each instalment can get complex. This is where FIFO simplifies the process.

FIFO impacts both the cost of acquisition and the holding period. Capital gains are calculated using the purchase price of the oldest units, which helps determine whether gains are short-term or long-term.