Mutual funds have their own set of rules and regulations for taxation. It varies based on the duration these funds were held. However, it may cause confusion in situations where the units are inherited. The questions about legal ownership, taxation on inherited mutual funds, etc., may arise.
This article will guide you to understand the taxation of mutual funds, what date is taken into account for calculating the duration of ownership, the calculation of capital gain, etc. To clear up all the confusion, let us dive deeper into the concept.
Understanding Inherited Mutual Fund Investments
Mutual fund units transferred to a beneficiary (legal heir or nominee) following the death of the original investor are referred to as inherited mutual funds.
Key Features:
- No Immediate Tax Obligation: There is no tax due when mutual fund units are inherited.
- Tax Only Appears During Sale: You only pay taxes when you sell the units to gain profits.
- Date of Original Purchase Is Important: The date and price at which the deceased originally purchased the units are used to compute capital gains.
- Nominee is not the Legal Owner: A nominee is merely a guardian. Legal heirs bear real ownership and tax obligations upon redemption.
How to Calculate Capital Gains on Inherited Mutual Funds?
Now we know that there is no direct taxation on inherited mutual funds. But it is important for the nominee to know the calculation of capital gains. Let us understand it:
Important Guidelines for Calculating Capital Gains:
- The initial investment date and cost are passed down to the legal heirs, not the nominee; the original date of purchase of units by the deceased investor is considered for calculating capital gains.
- In order to ascertain whether your gains are short-term or long-term, your holding period incorporates the holding period of the original investor.
- Taxes only apply at the time of redemption. This means when transferring the units into your name, there is no tax due.
Smart Tax Planning Strategies for Inherited Mutual Funds
Let us look at some smart tax planning strategies that will reduce your tax obligations so that your net returns are not much affected:
1. Before redeeming, know the type of fund
- Equity mutual funds, which invest the majority in stocks, become more tax-efficient after one year.
- After three years, debt mutual funds provide indexation benefits, which can drastically lower taxable gains.
- You can choose when and how much to redeem by knowing the type of fund.
2. Strategically Time Your Redemption
- Refrain from selling the units as soon as you inherit them.
- To take advantage of reduced tax rates, wait until the investment qualifies as long-term capital gains (LTCG), which is over a year for equity funds and over thirty-six months for debt funds (including the holding period for the deceased).
3. Benefit from Indexation (Only for Debt Funds)
- Use the Cost Inflation Index (CII) as it will help in reducing capital gains and raising acquisition costs.
- This tactic is particularly helpful if the investment was held for a long time prior to inheritance.
4. Make Ownership Clear: Legal Heir vs. Nominee
- A nominee merely looks after the investment.
- The true owners are the legal heirs, who must pay the redemption tax.
- Make sure the money is moved to the legitimate heir’s name before redeeming.
5. Before redeeming, make sure to transfer funds correctly.
- Redeeming the units in the deceased’s name directly could result in tax and legal problems.
- Send the required paperwork to the mutual fund company:
- Certificate of Death
- KYC records
- Form for requesting transmission
- Document proving succession, for example, a legal heir affidavit, succession certificate, or will.
- Redeem only after units have been transferred into your name.
6. Examine Partial Redemptions
- Consider selling the investment in smaller chunks over several fiscal years rather than redeeming it all at once.
- Don’t go over the ₹1 lakh equity LTCG exemption limit.
- Refrain from hopping into higher tax slabs, particularly for debt fund STCG.
7. For Large Portfolios, consult with a Tax Advisor
Tax advisors are professionals, and they will give advice only after understanding your situation. It is important to disclose all the relevant information to get the maximum benefit.
Bottomline
We can conclude that understanding legal ownership is important before understanding taxation. Paperwork and documentation play an essential role in ensuring legal compliance and avoiding any dispute or penalty in the future. No tax is charged when the heir inherits the mutual fund units, but only at the time of selling these units.
At the time of selling, tax is levied on the basis of duration of holding, type of fund, and the slab rate of the individual and the capital gain.