Mutual Fund Taxation Explained: How FIFO Rule Works and How It Impacts Your Capital Gains

When it comes to investments, calculating taxes on mutual funds is often more complex than on fixed deposits or real estate. This complexity arises because taxation on mutual funds depends not only on the profits you earn but also on the duration of your investment. The Income Tax Department uses the FIFO rule—First In, First Out—to determine how your units are taxed. Understanding this method is crucial for investors, especially those who invest regularly through SIPs (Systematic Investment Plans).

What is FIFO in Mutual Funds?

FIFO stands for First In, First Out. According to this rule, when you redeem (sell) mutual fund units, the units that you purchased first will be considered sold first.

For example:

• Suppose you bought 200 units of a mutual fund in January 2024 and another 200 units in January 2025.

• If you sell 150 units in August 2025, the tax will be calculated on the units bought in January 2024, since they are considered the "first in."

This classification directly determines whether your gains fall under short-term capital gains (STCG) or long-term capital gains (LTCG).

How FIFO Impacts Taxation

The nature of your gains—short-term or long-term—depends on how long you held the units considered sold under FIFO.

• Equity Mutual Funds:

  • If held for more than 12 months, the gains are classified as long-term and taxed at 12.5%.

  • If sold within 12 months, the gains are considered short-term and taxed at 20%.

• Debt Mutual Funds:

  • The taxation is different here. Gains are added to your income and taxed as per your income tax slab rate.

This makes it vital to know which batch of units is being sold first, as even a few days can change whether your profits are taxed as short-term or long-term gains.

Example of Capital Gains Calculation

Let’s say you purchased 200 units for ₹2,000 and later sold 150 units for ₹3,000.

• Cost of acquisition (as per FIFO): ₹1,500

• Sale value: ₹3,000

• Capital gain: ₹1,500

Depending on when those 150 units were purchased (based on FIFO), this gain will either be taxed as STCG or LTCG.

Why FIFO Matters for SIP Investors

The FIFO rule becomes particularly important for investors who use SIPs. In SIPs, units are purchased at different times each month. When redemptions are made, the tax calculation applies to the earliest batch of units first.

This means:

• If your older SIP installments have crossed the holding period, they may qualify for long-term gains.

• Meanwhile, the newer units may still fall under short-term gains.

Understanding FIFO can help you plan redemptions better, reduce tax liabilities, and avoid surprises while filing income tax returns.

Key Takeaways for Investors

Always track purchase dates of your units to know which ones will be taxed first under FIFO.

Check your holding period carefully—crossing the 12-month mark in equity funds can lower your tax rate significantly.

SIP investors need to be extra cautious, as each month’s investment has a separate purchase date.

For debt funds, remember that taxation is linked to your income tax slab, not holding period.

Maintain proper records or use your demat statement, as it automatically applies FIFO for tax reporting.

Final Word

While mutual funds are an effective wealth-building tool, taxation plays a major role in determining your actual returns. The FIFO rule is central to how capital gains are calculated, and understanding it can save you both confusion and money. If you invest regularly, especially through SIPs, make sure you keep track of your units and plan redemptions strategically. This will help you maximize returns while staying compliant with tax laws.