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Should you pay home loan EMI by SWP from mutual funds?

Posted on 17 Jul 2024
Author: Sayan Sircar

Tags: Loans ; Tax

10 mins read
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This article explores how paying home loan EMI via regular withdrawals from mutual funds can be beneficial.

Should you pay home loan EMI by SWP from mutual funds?

This article is a part of our detailed article series on the concept of tax savings using Section 54F. Ensure you have read the other parts here:

How to save tax using Section 54F for an under construction house?

This article shows you the right way to apply Section 54F to save tax when you sell shares and mutual funds to buy an under-construction house.

Frequently asked questions on Section 54F: the complete guide

This article compiles an exhaustive list of FAQs on the concept of tax saving while purchasing a house under Section 54F.

Sec 54F: a hack that can save lakhs in taxes when you buy a house

This article shows how to save capital gains taxes under income tax Section 54F when you sell other assets to raise money to buy your first or second house.

📚 Topics covered:

What is an SWP?
Why use an SWP to pay home loan EMI?
What is Section 54F?
- How to use SWP to pay home loan EMI and pay no tax?
Which conditions must hold to save tax while using SWP to pay home loan EMI?
- Mutual fund profits must be long-term:
- The house must be your first or second
How long can you run SWP to pay home loan EMI?
What are the benefits of running SWP to pay home loan EMI?
- Increase the cost basis of your mutual funds
- Clean up your mutual fund portfolio

What is an SWP?

SIP SWP and STP

All of these are standing instructions that get executed as per a schedule you specify:

Systematic Investment Plan (SIP): Money from a bank account is invested into a mutual fund, typically once a month
Systematic Transfer Plan (SIP): Units from a mutual fund are redeemed to invest in another mutual fund of the same AMC
Systematic Withdrawal Plan (SWP): This is the reverse of the SIP. You sell the units from a mutual fund to send money to a bank account

A Systematic Withdrawal Plan (SWP) is an instruction to a mutual fund to sell a fixed amount every month and send that amount to your bank account.

An SWP can be an option for:

retired investors to create a sort of monthly salary from their investments: Can you run an SWP from mutual funds when you are retired?
parents to pay the college fees for their children
paying the EMI for a large loan like a home loan

Since the SWP is essentially a regular sell transaction in mutual funds, each sell transaction will require you to pay capital gains tax: How to calculate and save tax on mutual funds?

Why use an SWP to pay home loan EMI?

In this article, we will explore the situation where you can use an SWP from mutual funds to pay your home loan EMI but still save capital gains tax.

Of course, if you do not have any source of income, then selling your investments, whether by SWP or not, is the only way to pay off a home loan. In this article, we will explore the case of:

having a regular income from salary
paying the loan EMI from SWP
investing the EMI amount into mutual funds
not paying any tax on the SWP

Section 54F of the Income Tax Act makes the last bit, i.e., not paying any tax on the SWP, possible under certain conditions.

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What is Section 54F?

Introduced in 1983, Section 54F of the Income Tax act, as sourced from the Income Tax website, allows us to save capital gains tax if we sell mutual funds to buy a house.

Insertion of new section 54F.
12. In the Income-tax Act, after section 54E, the following section shall be inserted with effect from the 1st day of April, 1983, namely: —

'54F. Capital gain on transfer of certain. capital assets not to be charged in case of investment in residential house.

The basic premise of this tax exemption is very simple:

you wish to buy a house in India as an individual or HUF
you sell Mutual funds, shares, gold etc, to buy the house
on the date of the MF sale, you do not already own more than one house
you don’t have to pay capital gains taxes (only if it is long term gains) on the MF/shares/gold you sold

Complete details on the concept of Section 54F are here: Sec 54F: a hack that can save lakhs in taxes when you buy a house

How to use SWP to pay home loan EMI and pay no tax?

The steps to follow are:

locate a suitable mutual fund to create SWP
SWP sale amount comes to the bank account
pay EMI from that amount
invest the EMI amount into the same (or a suitable mutual fund) as per your goals

Also read
A Quick Primer on Dividends and their Taxation for Residents and NRIs

Which conditions must hold to save tax while using SWP to pay home loan EMI?

Mutual fund profits must be long-term:

equity-taxed fund units older than a year
debt-taxed fund units older than three years (if purchased before 1st April 2024)

When setting up the SWP, you should be 100% certain that the units are older than the LTCG limit or will be on the SWP execution date.

The house must be your first or second

You can get Section 54F exemption for either your first or second house. If you have, or had in the past, multiple houses, then 54F exemption is not possible.

How long can you run SWP to pay home loan EMI?

Using the SWP method to pay off a home loan makes sense only as long as you have 54F tax benefits. Otherwise, you are unnecessarily paying capital gains tax. Section 54F benefits are available only within a particular date range depending on when the house was purchased.

We have an easy-to-use calculator for Section 54F exemption calculation.

Section 54F Calculator

We will use Google sheets to create a simple calculator for this calculation. There is a link to download a pre-filled copy of the Google sheet via the button below.

Important: You must be logged into your Google Account on a laptop/desktop (and not on a phone) to access the sheet.

For under-construction properties, you can get 54F benefits within one year before and one year after the agreement or allotment or Builder Buyer Agreement (BBA) date.

Your SWP must end within a year of this date, or else you will not get any 54F benefit.

For a resale or ready-to-move house, you will get a 54F benefit within one year before and two years after the registration date.

Your SWP must end within two years of the registration date, or else you will not get any 54F benefit.

In either case, you should replenish your mutual funds by investing the EMI amount back into the portfolio.

To understand which funds to sell for your home loan repayment:

What are the benefits of running SWP to pay home loan EMI?

We are assuming that you are doing SWP only for Section 54F benefits and investing the EMI back.

Increase the cost basis of your mutual funds

This point helps you to save taxes in the future. Imagine that:

you invested 1 lakh in mutual funds on 1st January 2018 (1 lakh units, ₹10 price)
that grew to 1.2 lakhs on 1st January 2022 (20,000 profit as capital gains at ₹12 price)
you sell these units and pay one loan EMI (no tax due to 54F)
you purchase the same amount of mutual funds using your own funds. You have now purchased these units at ₹12
future capital gains tax on these units will be on ₹12 cost basis and not on ₹10. It will save tax on ₹2 profit per unit.

Clean up your mutual fund portfolio

It is possible that over time you have accumulated particular mutual funds that you do not want today. This concept of Section 54F benefit will allow you to get rid of them without worrying about tax. The same can be true if you are planning a tax-free switch from regular to direct funds.

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