Budget 2026: How ₹1.25 lakh LTCG tax limit and exclusion from 87A rebate hurt salaried mutual fund investors

As the Union Budget 2026-27 approaches, there is growing anticipation among taxpayers and tax experts that the central government could further expand the scope of the Section 87A rebate and increase the threshold of long-term capital gains (LTCG) tax to provide greater relief to the middle class.

In the previous Union Budget, the government announced that individuals earning up to ₹12 lakh a year, under the new tax regime, will have to pay zero tax. While this is largely true, it comes with an important caveat.

The zero tax liability is due to a rebate under Section 87A of the Income Tax Act, and it is not a blanket exemption for everyone. Those who invest in equity-based mutual funds with the aim of creating long-term wealth are not eligible for this special rebate.

Tax experts and the Association of Mutual Funds in India (AMFI) urged the government to amend rules and allow the rebate under Section 87A, provided the total income (including capital gains) does not exceed ₹12 lakh.

“Amend Section 87A of the Act (section 156 of the Bill) to allow the rebate of ₹60,000 to be applied after computing tax on special rate incomes (such as capital gains), provided the total income (including such gains) does not exceed ₹12 lakh,” said AMFI ahead of Budget 2026.

How 87A works

In 2025, Finance Minister Nirmala Sitharaman announced that citizens with an annual income of up to ₹12 lakh will be eligible for a rebate of ₹60,000 per financial year, directly reducing their tax liability.

Before the Union Budget 2025 reforms, under Section 87A, rebates were allowed even on income from capital gains through non-equity assets; but since last year, capital gains, which attract special tax like LTCG and STCG, will not be subject to rebate under 87A.

So, even though the government offers a ₹60,000 rebate under the new tax policy, people investing in mutual funds, despite earning less than ₹12 lakh a year, will have to pay capital gains tax.

Although there is a ₹1.25 lakh exemption threshold for taxpayers under the LTGC rebate norms, experts note that this limit is too low for a middle-class small investor earning under ₹12 lakh a year who invests in mutual funds.

Is LTCG tax-exempt limit too low?

In the Union Budget 2024, the central government increased the long-term capital gains (LTCG) tax to 12.5% under Section 112A of the Income Tax Act, while also increasing the exemption limit under the same to ₹1.25 lakh, compared to their earlier ₹1 lakh threshold levels.

“From a mutual fund perspective, I feel the threshold is very low. The government has been promoting long-term investment for many years, and accordingly, if a person is selling equity based on mutual fund units after 5-7 years, ₹1.25 lakh tax exemption is a low threshold,” said Mihir Tanna, Associate Director of Direct Tax at SK Patodia & Associate LLP.

Chartered Accountant Pankaj Kapoor, Assistant Professor of the School of Commerce at NMIMS Chandigarh, also added that the ₹1.25 lakh exemption can be seen as ‘relatively low’ as it has not been adjusted meaningfully for inflation or real investment growth over time.

Is this pinching India's middle class?

Experts said that the ₹1.25 lakh LTCG tax limit and exclusion from Section 87A rebate are turning out to be a pinch for the Indian middle-class segment, as small investors, despite earning lower than the exempted tax bracket of ₹12 lakh per annum, will be subject to paying 12.5% tax on capital gains on long-term investment.

“People usually invest in equity-based mutual funds with long-term planning, but when there is a need for money, they redeem them. Except for small investors, chances of getting gains above ₹1.25 lakh are very likely, and investors need to pay tax @12.5% on the gain, which pinches middle-class investors substantially,” Tanna told Mint.

AMFI also said that the lack of benefit from the ₹60,000 rebate, along with the tax liability, “undermines the stated goal of boosting savings and investments among the middle class”.

Will you pay tax despite being under ₹12-lakh limit?

Jignesh Shah, Partner - Direct Tax, Bhuta Shah & Co, explained with an example that if a person was earning a total income of ₹9 lakh (which includes ₹2.25 lakh of LTCG), then the person will not be able to claim the tax rebate on income under ₹12 lakh due to the LTCG component in their income.

The expert also shared an illustration of how, due to Section 87A, the tax structure requires a taxpayer to pay tax on LTCG even if the total income is well within the zero tax bracket.

Kapoor suggested extending the Section 87A rebate to include income taxed at special rates (LTCG and STCG), so that capital gains above the exemption can also benefit low- to middle-income taxpayers.

The expert also expects that raising or index-linking the LTCG exemption threshold above ₹1.25 lakh to reflect inflation and encourage long-term investing is a way to address the issue in the upcoming Budget 2026-27.

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Disclaimer: This story is for educational purposes only. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.