How switching MFs to dividend option to book unrealised loss can reduce your tax bill

With only a week remaining until the end of the current financial year, now is the right time for investors to book their unrealised losses to reduce the overall tax bill. Several investors may be sitting on losses this year, given the market correction over the last few months.

First, let us understand the tax rules for selling short term and long term investments.Short-term capital gains (STCG) on assets held for less than a year are taxed at 20% and long-term capital gains (LTCG) on assets held for over a year are taxed at 12.5% beyond ₹1.25 lakh. By selling loss-making investments before 31 March, investors can offset the losses against STCG or LTCG from other investments, thereby reducing the taxable amount.

But what if you are bullish on the mutual fund that is performing poorly and do not want to stop investing in it? You can still book the loss and immediately repurchase the MF. Financial advisers and wealth managers often switch from the growth option of the MF to the income distribution cum withdrawal (IDCW) plan option, and then switch back to the growth option once the losses are booked. IDCW are the dividend plans of the MF schemes.

“Switching from growth to dividend option of an MF is treated as redemption. So, you are booking losses while not actually selling the holding. The switch happens within the same day. The very next day, we place the switch-out request to move back to the growth option," said Bikam Chand, a family office wealth manager.

There is no volatility risk in this strategy as the switch happens on the same day as the net asset value (NAV) of both schemes. “The number of units after completing this whole exercise remains the same except for a marginal decrease as stamp duty and STT