Mutual Fund Tax Myths Investors Still Believe — 2026 Guide

In our previous blog on Equity Mutual Funds: Categories, Plans & Taxation, we discussed how the Grandfathering Rule ensured that investors were not taxed retrospectively when Long-Term Capital Gains (LTCG) on equity were reintroduced in 2018. That section ended with a promise — to decode the many tax myths investors still believe.

This blog is that continuation.

Because while tax laws evolve with every Budget, investor assumptions often don’t. Rules that changed years ago, half-remembered advice, and platform-level oversimplifications continue to influence decisions — sometimes quietly eroding post-tax returns.

Through this blog, we address the most common mutual fund tax myths — across equity, debt, gold, SIPs, dividends, STP/SWP, ELSS and exits — and explain how taxation actually works today, not how it used to.

🧩The “All Mutual Funds Have the Same Tax Rules” Myth

Myth:
All mutual funds are taxed the same way. Long-term and short-term rules apply uniformly across equity and debt funds.

Fact:
Equity and debt mutual funds follow different tax frameworks.

• Equity funds: Short-term ≤ 12 months, Long-term > 12 months
• Debt funds: Tax rules changed significantly post April 2023; holding period alone no longer decides concessional tax treatment. All Debt funds are now considered Short-term irrespective of the holding period.

Investor Takeaway ⭐
Applying a single tax rule across all mutual funds can lead to incorrect product selection and unrealistic return expectations.

📈 The “Long-Term Equity is Tax-Free” Myth

Myth:
If equity mutual funds are held long-term, there is no tax on gains.

Fact:
Since 2018, LTCG tax applies to equity mutual funds.

• Gains up to ₹1.25 lakh per financial year are exempt
• Gains above that are taxed at 12.5% (without indexation)

Investor Takeaway ⭐
Equity investing is still tax-efficient, but not tax-free. Ignoring this leads to surprises at redemption.

🗓️ The “Pre-2018 Equity Investments Are Fully Tax-Free” Myth

Myth:
Equity mutual funds purchased before 2018 will never be taxed.

Fact:
The Grandfathering Rule protects gains accrued only up to 31 January 2018.
Any appreciation after that date is taxable at the time of redemption.

Investor Takeaway ⭐
Many long-term investors overestimate how much of their gains are actually exempt from tax.

🔄 The “Old Investments Follow Old Tax Rules” Myth

Myth:
If an investment was made under old tax rules, those rules continue to apply forever.

Fact:
Taxation is determined at redemption, not at the time of investment.
Current tax laws apply to all redemptions, regardless of when the investment was made—except for grandfathered gains.

Investor Takeaway ⭐
Legacy investments still need to be evaluated under today’s tax framework.

💸 The “Dividend is Tax-Free” Myth

Myth:
Dividends from IDCW (Income Distribution cum Capital Withdrawal) mutual fund plans are tax-free income.

Fact:
Dividend Distribution Tax (DDT) was abolished in 2020.
Today, all IDCW payouts (dividends) are added to your total income and taxed at your applicable slab rate (which could be as high as 30% or more).
Furthermore, AMCs deduct 10% TDS if your dividends exceed ₹5,000 in a financial year. Additionally, NAV falls after every payout.

Investor Takeaway ⭐
Dividends are not extra income—they are distributions of your own investment, often with a higher tax impact.

📅💰 The “SIP Taxation” Myth

Myth: If I started my SIP 13 months ago, my entire withdrawal is now Long-Term and tax-free up to ₹1.25 lakh.

Fact:
Each SIP instalment is treated as a separate investment with its own purchase date and holding period.
At redemption, some units may be long-term, others short-term—tax is calculated unit-wise.

Say you invested 10K every month start of the year and you redeem them in March next year. The table shows the tax treatment for first three SIPs.

Investor Takeaway ⭐
SIPs simplify investing, not taxation. Poor planning can lead to unexpected short-term capital gains tax.

⏱️🔓 The “Selling ELSS After Lock-In Means No Tax” Myth

Myth:
Once the 3-year lock-in period of an ELSS fund ends, units can be sold without paying any tax.

Fact:
The lock-in period of 3 years and taxation at redemption are two separate concepts.
ELSS funds qualify for tax deduction under Section 80C at the time of investment, but redemption is still subject to equity mutual fund capital gains tax.

• ELSS held for more than 12 months qualifies as long-term
• LTCG rules apply at redemption
• Gains up to ₹1.25 lakh per financial year are exempt
• Gains above that are taxed at 12.5%, without Indexation.

Investor Takeaway ⭐
ELSS helps save tax at entry, not at exit. Treating lock-in as a tax exemption can lead to incorrect exit planning and unexpected tax outgo.

🏦 The “Debt Funds Are Always Tax-Efficient” Myth

Myth:
Debt mutual funds are always better than fixed deposits from a tax perspective.

Fact:
Debt Mutual fund bought before 1-April, 2023, and redeemed after 23-July, 2024, are taxed at 12.5%, without indexation.
Debt Mutual fund bought after 1-April, 2023, is taxed at the investor’s slab rate, irrespective of holding period.

Investor Takeaway ⭐
Debt funds are no longer automatic tax winners; suitability now depends on liquidity, horizon, and slab rate.

🚫 The “Indexation Always Applies to Debt Funds” Myth

Myth:
Indexation benefit applies to all long-term debt mutual fund investments.

Fact:

Indexation was a major advantage before 2023.

• Allowed inflation-adjusted cost
• Reduced taxable gains significantly

Indexation benefit was largely removed after April 2023 for most debt mutual funds.
Inflation-adjusted cost calculation is no longer available in most cases.

Investor Takeaway ⭐
Many investors still calculate post-tax returns assuming indexation—leading to overestimated outcomes.

🔁💰 The “STP & SWP Save Capital Gains Tax” Myth

Myth:
STP and SWP are tax-efficient ways to avoid capital gains tax.

Fact:

• STP: Each transfer is treated as a redemption from the exiting fund→ capital gains tax applies every time based on the fund type- Equity or Debt.
• SWP: Each withdrawal has a capital portion (not taxed) and a gains portion (taxed as STCG or LTCG)

Say you invest ₹6,00,000 in a debt fund and start a monthly STP of ₹50,000 into an equity fund after 3 months.

Investor Takeaway ⭐
STP and SWP are cash-flow and risk-management tools—not tax-saving strategies.

🪙 The “Gold ETF, Gold MF and Physical Gold All Follow Equity Taxation” Myth

Myth

Gold ETFs, Gold Mutual Funds and Physical Gold are taxed like equity mutual funds.

Fact (Post Budget 2024 / effective 01.04.2025)

👉Gold does NOT follow equity taxation.
Each gold instrument has its own holding period and tax rules.

🔶 Gold ETF

• Traded on stock exchanges, held in Demat
• STCG: Held ≤ 12 months → Taxed at slab rate
• LTCG: Held > 12 months → 12.5% (no indexation)
• ❌ No ₹1.25 lakh exemption (Section 112A does not apply)

🔶 Gold Mutual Fund

• Fund of Funds investing in Gold ETFs (no Demat needed)
• STCG: Held ≤ 24 months → Taxed at slab rate
• LTCG: Held > 24 months → 12.5% (no indexation)
• ❌ No equity-style exemption

🔶 Physical Gold (Jewellery / Coins / Bars)

• GST: 3% on purchase (+ making charges for jewellery)
• STCG: Sold within 24 months → Taxed at slab rate
• LTCG: Sold after 24 months → 12.5% (no indexation)

Investor Takeaway ⭐

Gold investments may look market-linked, but they do not enjoy equity tax benefits.
There is no LTCG exemption like equity mutual funds, and holding period rules differ across gold instruments. Treating gold like equity can lead to wrong post-tax return expectations.

➖➕ The “All Capital Losses Can Be Set Off Freely” Myth

Myth:
Capital losses from any mutual fund can be adjusted against any capital gains.

Fact:
Set-off rules are specific:

• Short-term Capital Loss (STCL) → can offset against Short-term Capital Gain (STCG) and Long-term Capital Gain (LTCG)
• Long-term Capital Loss (LTCL) → can offset against only LTCG
• Losses can be carried forward for 8 years (subject to conditions)

Investor Takeaway ⭐
Understanding set-off rules helps reduce tax legally; misunderstanding them leads to missed opportunities.

🎁 The “Gifting Mutual Fund Units Is Completely Tax-Free” Myth

Myth:
Gifting mutual fund units avoids tax for both the giver and the recipient.

Fact:
Gifting mutual fund units does not trigger capital gains tax at the time of gifting, but taxation is not eliminated.

• When the recipient redeems the units, capital gains tax applies
• Cost of acquisition and holding period are inherited from the original investor
• In certain relationships, clubbing provisions may apply

Investor Takeaway ⭐
Gifting can be useful for estate and family planning, but it is not a tax-escape route. Misunderstanding this can lead to incorrect tax reporting later.

🎯 The “Tax should be the first filter when choosing mutual funds” myth

Myth:
Mutual funds should be selected primarily based on tax benefits. Lower tax automatically means a better investment.

Fact:
Tax is only one component of investing—not the foundation.
The right sequence is:

1. Financial goals
2. Time horizon
3. Risk appetite
4. Appropriate fund category
5. Fund selection
6. Tax impact

Choosing a fund purely for tax reasons can lead to mismatched risk, poor returns, or liquidity issues.

Investor Takeaway ⭐
Tax optimisation without goal alignment often backfires. Paying tax usually means you made money—poor planning means you didn’t. Smart investing focuses on outcomes first, tax efficiency second.

If there’s one clear takeaway from all these myths, it’s this:
tax laws will keep changing — but your investment decisions shouldn’t be based on outdated assumptions.

Successful investing isn’t just about choosing the right mutual fund. It’s about understanding how that investment behaves across its entire lifecycle — from the day you invest, to interim payouts, switches, withdrawals, and finally redemption. That’s where most investors get caught off guard.

At InvestAlly, we look at mutual funds end-to-end.
We help you select the right funds for your goals and risk appetite — and equally important, we help you understand what tax implications apply at every stage, so there are no surprises later.

📌 In an ever-evolving tax landscape, the smartest investors focus on long-term outcomes — and leave fund selection, portfolio structure, and tax interpretation to professionals who track the rules closely.

If you want clarity on how current tax laws impact your mutual fund portfolio — or want to invest with confidence knowing both returns and taxes are thoughtfully planned — it might be time to have that conversation.