Planning to redeem your mutual funds? Know how FIFO method affects capital gains tax, how it is calculated

Investing in equity mutual funds is one of the most popular ways for individuals to build long-term wealth. However, when investors redeem or sell their mutual fund units, they may have to pay capital gains tax depending on the profit earned and the holding period. One of the most important rules used to calculate this tax is the FIFO method, which stands for “First In, First Out".

The FIFO method plays a key role in determining which mutual fund units are considered sold first when an investor has purchased the same fund units on different dates and at different prices. This directly affects the amount of capital gains tax payable.

What is the FIFO method?

FIFO means that the units purchased first are treated as the first ones to be sold. This method is used by the Income Tax Department to calculate capital gains on mutual fund redemptions.

For example, if an investor buys units of the same equity mutual fund in multiple installments through SIPs (Systematic Investment Plans) or lump sum investments, and later redeems only a portion of those units, the tax calculation will assume that the oldest units were sold first.

This is important because each purchase date determines the holding period of that batch of units, which decides whether the gain is classified as short-term or long-term.

Short-term vs Long-term capital gains

In equity mutual funds, if the units are sold within 12 months of purchase, the profit is treated as Short-Term Capital Gain (STCG). If the units are sold after 12 months, it is considered Long-Term Capital Gain (LTCG).

STCG on equity mutual funds is taxed at 20%, while LTCG above ₹1.25 lakh in a financial year is taxed at 12.5% without indexation. Gains up to ₹1.25 lakh under LTCG are exempt from tax.

This is why FIFO becomes significant, it helps determine which units qualify for LTCG and which fall under STCG.

Why FIFO matters for SIP investors

Most SIP investors purchase mutual fund units every month. Each installment creates a separate purchase record with a different Net Asset Value (NAV) and purchase date.

When redemption happens, FIFO ensures that the oldest units are sold first, which may help investors reduce tax if those units qualify for LTCG exemption.

This makes tax planning easier and more efficient, especially for long-term investors who redeem partially rather than withdrawing the full investment.

The FIFO method is a standard rule used for calculating capital gains tax on equity mutual funds in India. It ensures that the earliest purchased units are treated as sold first, helping determine the holding period and applicable tax.

Understanding FIFO is essential for every mutual fund investor, especially those investing through SIPs. It not only affects the final tax outgo but also helps in better planning of redemptions to maximize tax efficiency and returns.

Disclaimer: This article is intended for general informational and educational purposes only and should not be treated as financial or investment advice from Mint. Readers are advised to conduct their own research and seek guidance from a qualified financial advisor before making any investment decisions.