Still holding equity funds bought before February 2018? The grandfathering clause changes your tax bill

If you bought an equity mutual fund before 1 February 2018 and are only now thinking of redeeming it, the tax you owe is not calculated the way most calculators assume. A single clause buried in Section 112A of the Income Tax Act, 1961 - the grandfathering provision inserted by the Finance Act 2018 - can legitimately erase several years of gains from your tax base. Used correctly it is worth tens of thousands of rupees; ignored, you overpay. This Midday Pulse compares the two ways your cost of acquisition can be computed - the actual purchase cost versus the grandfathered Fair Market Value (FMV) as on 31 January 2018 - and shows which one a long-term holder should pick, with the arithmetic worked out in full.

The stakes rose on 23 July 2024. The Finance Act (No. 2) 2024 raised the long-term capital gains rate on listed equity and equity-oriented funds from 10% to 12.5%, and lifted the annual exemption from Rs 1,00,000 to Rs 1,25,000. Both changes mean the grandfathering shield now protects gains that are taxed harder than they were before, so getting the cost base right matters more in FY 2025-26 than it did a year earlier.

Side-by-Side Comparison

Grandfathering is not an optional scheme you elect into - it is a mandatory rule for how cost is read off the record for any listed equity share or equity-oriented fund unit acquired before 1 February 2018. Under the proviso to Section 55(2)(ac), the cost of acquisition for such a holding is the higher of: (a) the actual cost of acquisition; or (b) the lower of the FMV as on 31 January 2018 and the full value of consideration received on sale. Units bought on or after 1 February 2018 get no such substitution - their cost is simply what you paid.

The table below contrasts the two cost bases for a holder who invested Rs 2,00,000, whose units were worth Rs 3,50,000 on 31 January 2018, and who redeems in FY 2025-26 for Rs 6,00,000. Both columns use the same 12.5% rate and Rs 1,25,000 exemption that apply from 23 July 2024.

The grandfathered holder pays Rs 16,250 against Rs 35,750 - a saving of Rs 19,500, or about 55%, entirely because the appreciation between purchase and 31 January 2018 is carved out of the taxable gain. For a fuller picture of how long-term capital gains are measured against the holding period, note that equity and equity-oriented funds become long-term only after 12 months; sell inside that window and you face short-term capital gains at 20% under Section 111A, with no grandfathering and no FMV substitution at all.

You can reproduce this comparison for your own figures on the Oquilia LTCG Equity Calculator, which applies the higher-of/lower-of logic automatically once you enter purchase cost, 31 January 2018 value and sale price.

How to find the 31 January 2018 FMV

The FMV input is where most self-filers go wrong, so it is worth being precise. The Finance Act 2018 defines it differently for listed shares and for fund units. For a listed equity share, the FMV is the highest price of the share quoted on a recognised stock exchange on 31 January 2018; if there was no trading that day, it is the highest price on the immediately preceding date on which the share traded. For an equity-oriented mutual fund unit, which is not quoted intra-day, the FMV is the net asset value (NAV) of the unit as published on 31 January 2018.

That NAV is not something you estimate. AMFI publishes historical NAVs, and the 31 January 2018 cut-off NAV for every scheme is available on the AMFI portal, so your NAV-based FMV should be copied from the official record rather than guessed. Multiply the 31 January 2018 NAV by the number of units you held on that date to get the FMV figure that feeds row (b) of the cost test. If you have made several purchases over the years, the test is applied lot by lot - only the lots bought before 1 February 2018 qualify for substitution, while SIP instalments bought from February 2018 onward are valued at their actual cost.

A second worked case shows why the clause is written as a "higher of / lower of" sandwich rather than a simple FMV swap. Suppose the same Rs 2,00,000 holding, with a 31 January 2018 FMV of Rs 3,50,000, is redeemed for only Rs 3,00,000. Here row (b) is the lower of the FMV (Rs 3,50,000) and the sale value (Rs 3,00,000), which is Rs 3,00,000; the deemed cost is then the higher of the actual cost (Rs 2,00,000) and Rs 3,00,000, so Rs 3,00,000. The taxable gain is Rs 3,00,000 minus Rs 3,00,000 - exactly nil. The structure deliberately prevents an investor from manufacturing an artificial capital loss out of the January 2018 high-water mark, which is why you can never use grandfathering to book a loss larger than your real economic loss.

Tax Treatment

The headline numbers for FY 2025-26 are fixed and should not be confused with the pre-2024 figures that older articles still carry. Long-term gains on listed equity shares and equity-oriented funds are taxed under Section 112A at 12.5% on the aggregate gain exceeding the Rs 1,25,000 annual exemption, a rate and threshold that took effect for transfers on or after 23 July 2024 per the Finance Act (No. 2) 2024. For transfers before that date in the same year, a 10% rate on gains above Rs 1,00,000 applied - relevant only if you are still filing a back year.

Three further mechanics decide the final cheque. First, there is no indexation on equity LTCG; the cost-inflation indexation benefit was never available under Section 112A and remains unavailable, which is precisely why the one-time 31 January 2018 FMV substitution exists as a substitute shield. Second, a 4% health and education cess is added to the tax plus any surcharge, as in both worked examples above. Third, where total income crosses the surcharge thresholds, surcharge applies - but surcharge on capital gains chargeable under Sections 111A and 112A is capped at 15%, so the top 25% rate that applies to other income does not reach these equity gains.

The Rs 1,25,000 exemption is a single annual bucket across all your listed-equity and equity-fund gains combined, not per scheme or per folio - a point confirmed by the way the capital asset gains are aggregated on the return. If you are redeeming a large pre-2018 holding, splitting the sale across two financial years lets you use two years' worth of the Rs 1,25,000 exemption, and the grandfathered cost base is preserved on both tranches because it attaches to the units, not the sale date.

Who Should Pick Which

Strictly, you do not "pick" between the actual-cost and grandfathered bases - the law tells you to use whichever is higher under the Section 55(2)(ac) test. But the practical decision for an investor is whether a pre-February 2018 holding is worth keeping on the books at all, given that the FMV shield only helps while those specific units remain unsold. The profiles below frame that choice.

The long-standing buy-and-hold investor. If you hold units bought in, say, 2014-2017 that appreciated strongly up to 31 January 2018, grandfathering is doing heavy lifting for you - as the first example showed, it removed Rs 1,50,000 of gain and halved the tax. Redeem these lots deliberately and in tranches that stay near the Rs 1,25,000 exemption each year, and confirm the 31 January 2018 NAV from the AMFI record before filing. Once sold, the shield is gone; a fresh purchase of the same fund resets the cost to today's NAV with no FMV benefit.

The SIP investor who started before 2018 and continued. Your folio is a mix of grandfathered and non-grandfathered lots. Because equity funds are redeemed on a first-in-first-out basis, your oldest - and most grandfather-protected - units are deemed sold first. That is usually favourable, but it means a partial redemption can exhaust your grandfathered lots early, after which later withdrawals carry the full taxable gain. Model the FIFO sequence on the LTCG Equity Calculator before redeeming.

The tax-saver (ELSS) holder. ELSS units bought before 1 February 2018 under Section 80C are equity-oriented and fully eligible for grandfathering once their three-year lock-in has passed - which it has, long ago, for any pre-2018 purchase. If you are still deciding between ELSS and other 80C options for fresh money, the ELSS calculator lets you compare lock-in-adjusted post-tax outcomes, but for your existing old units the message is the same: the 31 January 2018 FMV is already locked in as your floor.

The investor sitting on a loss. If your units are worth less today than the 31 January 2018 FMV, the higher-of/lower-of test caps your deemed cost at the sale value, so you cannot book a tax loss greater than your true economic loss. Do not expect the January 2018 peak to generate a deductible loss the law explicitly designed the "lower of" leg to prevent.

FAQ

What exactly is the grandfathering clause for equity funds?

It is the proviso to Section 55(2)(ac) of the Income Tax Act, inserted by the Finance Act 2018 when long-term capital gains on listed equity were made taxable again from 1 April 2018. For units acquired before 1 February 2018, the cost of acquisition is read as the higher of the actual cost and the lower of the 31 January 2018 FMV and the sale value. The effect is that appreciation up to 31 January 2018 is not taxed.

Does grandfathering still apply after the 2024 rate change?

Yes. The Finance Act (No. 2) 2024 changed only the rate (10% to 12.5%) and the exemption (Rs 1,00,000 to Rs 1,25,000) with effect from 23 July 2024. It did not touch the Section 55(2)(ac) cost-substitution rule, so the 31 January 2018 FMV floor continues to apply to all qualifying pre-February 2018 holdings.

Where do I get the 31 January 2018 NAV for my fund?

For equity-oriented fund units, the FMV is the scheme NAV published for 31 January 2018, available from the AMFI historical-NAV records. For a listed share it is the highest quoted price on a recognised stock exchange on 31 January 2018, or on the nearest prior trading day if the share did not trade that day.

Is indexation available on these gains?

No. Equity LTCG under Section 112A has never carried indexation. The one-time 31 January 2018 FMV substitution is the shield the law provides instead, and it applies only to units bought before 1 February 2018.

How much of my equity gain is exempt each year?

For FY 2025-26, the first Rs 1,25,000 of aggregate long-term gains from listed equity shares and equity-oriented funds is exempt. The balance is taxed at 12.5% plus 4% cess, with surcharge on such gains capped at 15% where income thresholds are crossed.

Do units bought after 1 February 2018 get any FMV benefit?

No. Only units acquired before 1 February 2018 qualify for the FMV substitution. Units bought on or after that date use their actual purchase cost, which is why a mixed SIP folio must be computed lot by lot.

What happens to grandfathering if I switch funds?

A switch between schemes is treated as a redemption plus a fresh purchase. Switching out of a pre-2018 holding triggers the gain and permanently ends the grandfathering shield on those units; the new units bought by the switch start at the current NAV with no FMV benefit.