ITR-1 vs ITR-2: Which Form Should You File If You Have Capital Gains from Mutual Funds?

Kunal KunduByKunal Kundu
ITR-1 vs ITR-2 comparison for mutual fund capital gains filing India 2026

The ITR-1 vs ITR-2 question trips up more salaried investors every July than almost any other filing decision. Here’s a scenario that plays out across thousands of Income Tax Department mailboxes every year: a salaried employee files ITR-1, the same form they’ve used for years, and three weeks later gets a “Defective Return — Section 139(9)” notice. The trigger is usually something small — a partial mutual fund redemption, sometimes for as little as ₹40,000, often to cover a one-off expense and not even profit-driven.

That single transaction is enough to make ITR-1 invalid for the year.

Here’s the part that catches most salaried Indians off guard in 2026: even one mutual fund redemption can change which ITR form you’re allowed to use. And this year, the rule got more complicated, not simpler — the Income Tax Department added a narrow exception that lets some people stay on ITR-1 despite having capital gains, but only if the fine print actually applies to you.

If you redeemed, switched, or ran an STP (Systematic Transfer Plan) out of any mutual fund in FY 2025-26, here’s exactly which form applies to you, why, and how to stay off the Department’s defective-return list.

The Basic Rule: Capital Gains Usually Mean ITR-2

ITR-1 (Sahaj) is the simplest income tax return — built for salary, one or two house properties, interest income, and not much else. It was never designed to handle capital gains reporting.

The Income Tax Department’s own return-applicability guidance is direct about this: capital gains income takes you out of ITR-1’s scope, full stop, in the general case.

That includes:

  • Selling equity mutual funds, even a partial redemption
  • Switching between two schemes of the same fund house (yes, this counts — more on that below)
  • An STP moving money from a liquid fund to an equity fund
  • Redeeming debt mutual funds, gold funds, or international funds
  • Selling ELSS funds after the 3-year lock-in

If any of this happened in your folio between April 2025 and March 2026, you fall into ITR-2 territory by default — unless you qualify for the one exception below. If you haven’t filed an ITR before or want the full walkthrough of the e-filing portal itself, The Salary Investor’s complete ITR filing guide covers that ground. This article goes one level deeper — specifically into the mutual fund capital gains mechanics that decide which form you’re even allowed to open.

The 2026 Exception: Small Equity LTCG Can Now Stay on ITR-1

This is genuinely new, and it is the reason this topic needs a fresh article instead of last year’s advice.

The CBDT notified revised ITR forms for AY 2026-27 in a notification dated 30 March 2026, with a corrigendum following on 10 April 2026. Buried inside the ITR-1 changes is a real concession for small investors: you can now report long-term capital gains (LTCG) under Section 112A — meaning gains from listed equity shares or equity-oriented mutual funds — directly in ITR-1, without being pushed to ITR-2.

Three conditions have to be true at the same time:

  1. Your total LTCG under Section 112A for the year is ₹1.25 lakh or less
  2. You have no capital losses to carry forward or set off
  3. You meet every other ITR-1 condition — income up to ₹50 lakh, salary/pension/interest income, and now up to two house properties

If even one of these fails, you’re back to ITR-2. The most common way people fail condition 1: they redeemed multiple equity fund SIPs through the year and didn’t add up the total gain before assuming they were under the limit.

Illustrative example: Priya, a 29-year-old product manager in Pune, redeemed ₹3 lakh from her Nifty 50 index fund SIP in September 2025, which she’d been running for four years. Her LTCG worked out to ₹98,000. She had no other capital losses. Her total income, including salary, was ₹14 lakh. She qualifies to stay on ITR-1 for AY 2026-27 — something that would have been impossible before this year’s form change.

Compare that to Rohan, a 34-year-old in Bengaluru earning ₹20 lakh, who redeemed equity mutual funds generating an LTCG of ₹2.8 lakh in the same year. Since his gain crosses ₹1.25 lakh, ITR-1 isn’t available to him regardless of how simple the rest of his income is. He has to file ITR-2.

Why a “Switch” or an STP Still Counts as a Sale

This trips up more people than outright redemptions do. If you switched from a Regular plan to a Direct plan of the same fund, or moved money via STP from a liquid fund into an equity fund, the Income Tax Department treats this as a redemption followed by a fresh purchase — not a transfer.

That means it generates a capital gain or loss, it shows up in your Annual Information Statement (AIS), and it has the same form-selection consequences as if you’d sold the units and walked away with cash. A lot of switches happen specifically to reduce expense ratio or move to a cheaper plan — the tax department doesn’t care about the investor’s intention, only the transaction.

If you’ve done a Regular-to-Direct switch this year purely to cut costs, check your AIS before assuming it didn’t generate a taxable event. It almost certainly did.

ITR-1 vs ITR-2: Side-by-Side Comparison

FeatureITR-1 (Sahaj)ITR-2
Who it’s forResident individuals, simple incomeIndividuals/HUFs with capital gains, multiple income sources
Income ceilingUp to ₹50 lakhNo ceiling
House propertiesUp to 2 (new for AY 2026-27)Unlimited
Equity LTCG (Sec 112A)Allowed only if ≤ ₹1.25 lakh, no losses to carry forwardAllowed at any amount
Equity STCG (Sec 111A)Not allowed at allAllowed
Debt mutual fund gainsNot allowedAllowed
Foreign assets/incomeNot allowedAllowed (with disclosure)
Capital loss carry-forwardNot allowedAllowed
Due date (non-audit, FY 2025-26)31 July 202631 July 2026

How Equity and Debt Mutual Fund Gains Are Actually Taxed

This part matters because it decides not just which form you file, but how much tax you owe.

Equity mutual funds (funds with 65% or more in domestic equity): Gains on units held 12 months or less are short-term capital gains (STCG) under Section 111A, taxed at a flat 20%. Gains on units held more than 12 months are long-term capital gains (LTCG) under Section 112A, taxed at 12.5% — but only on the amount above ₹1.25 lakh per financial year. This exemption is one of the few places ordinary salaried investors get real tax relief on equity gains.

Debt mutual funds (funds with more than 65% in debt and money market instruments, bought on or after 1 April 2023): Under Section 50AA, every gain — regardless of how long you held the units — is treated as short-term and taxed at your income tax slab rate. There’s no LTCG benefit anymore, and no indexation. This rule has been in place since the Finance Act 2023 and was narrowed slightly in 2024 to apply specifically to debt-oriented funds, but the core slab-rate treatment hasn’t changed.

Why this matters for your form: Even ₹5,000 of debt fund gain — taxed at slab rate, however small — keeps you out of ITR-1 entirely. There’s no small-amount exception for debt fund gains the way there is for equity LTCG.

Why SIP Redemptions Are Trickier Than a Lump-Sum Sale

A lump-sum investment has one purchase date, so the long-term/short-term split is simple. A SIP doesn’t work that way — every monthly instalment is treated as a separate purchase with its own date, under the First-In-First-Out (FIFO) method.

This means a single redemption from a SIP you’ve run for, say, three years can produce a mix of LTCG and STCG in the same transaction. The units bought more than 12 months ago count as long-term; the ones bought in the last 12 months count as short-term — even though you redeemed everything in a single click.

This is exactly why “I started this SIP four years ago, so it’s all long-term” is a common but incorrect assumption. Your fund house’s capital gains statement does the FIFO split automatically, which is one more reason to rely on the CAMS or KFintech statement rather than estimating it yourself. If your redemption mixes LTCG and STCG, you need ITR-2 regardless of how small the LTCG portion is, because the STCG portion alone disqualifies ITR-1.

Schedule 112A: What You Actually Have to Fill In

If you land on ITR-2, your equity LTCG goes into Schedule 112A. The good news: for mutual fund units bought after 31 January 2018 — which covers almost every SIP and lump-sum investment a salaried person made in the last several years — you don’t need scrip-by-scrip detail. You can report a consolidated total per ISIN, which most broker or RTA (Registrar and Transfer Agent) capital gains statements already give you in exactly that format.

Scrip-wise breakdown is only mandatory if you’re claiming grandfathering benefit on units purchased before 31 January 2018 — increasingly rare for anyone who started investing through SIPs in the last five or six years.

Practically: download your capital gains statement from CAMS or KFintech (or directly from your broker if you invest via a platform like Groww, Zerodha Coin, or Kuvera), and the ISIN-wise totals map almost directly into the Schedule 112A fields.

Step-by-Step: Figuring Out Your Form This Week

Five checks, in order, and you’ll know your form before you open the e-filing portal:

  • Pull your AIS. Log into the income tax e-filing portal, go to AIS, and check the “Sale of securities and units of mutual funds” section. This is the Income Tax Department’s own record of every redemption that hit your PAN — including switches and STPs you may have forgotten about.
  • Get your capital gains statement. Request a consolidated capital gains statement from CAMS (camsonline.com) or KFintech for all mutual fund folios, or download it from your investment platform. This separates equity from debt, and short-term from long-term, automatically.
  • Add up your equity LTCG. If it’s ₹1.25 lakh or below, and you have no losses to carry forward, and you meet every other ITR-1 condition — you may be eligible to stay on ITR-1 this year.
  • Check for any debt fund or STCG entries. Even one rupee of these takes you to ITR-2, no exceptions.
  • When in doubt, file ITR-2. Filing ITR-2 when ITR-1 would have worked costs you nothing except a slightly longer form. Filing ITR-1 when you needed ITR-2 gets you a defective return notice under Section 139(9), and you’ll need to refile.

What Happens If You File the Wrong Form

A return filed on the wrong form isn’t rejected outright — but once the Department’s systems cross-check your AIS against what you reported, it can be flagged defective under Section 139(9). Per the Income Tax Department’s own FAQ on this process, you get 15 days from the date you receive the notice to fix it, extendable if you write to the Assessing Officer before that window closes. Miss it entirely, and the original return is treated as if it was never filed — which brings back every consequence of non-filing, including a late fee and the loss of your right to carry forward capital losses.

There’s a separate, sharper deadline sitting underneath all this: if you have a capital loss this year and want to carry it forward to offset gains in future years, the return has to be filed by 31 July 2026 — the standard non-audit due date. A belated return filed after that date, even if otherwise accepted, won’t preserve that carry-forward right.

What to Do This Week

  • Log into the income tax portal and pull your AIS — don’t rely on memory for what you redeemed or switched
  • Download a consolidated capital gains statement from CAMS or KFintech
  • Total your equity LTCG separately from STCG and debt fund gains
  • If equity LTCG is ₹1.25 lakh or under with no losses to carry forward, check whether you also meet ITR-1’s other conditions
  • If anything else shows up — STCG, debt gains, losses to carry forward — plan to file ITR-2
  • Don’t wait until late July; AIS data sometimes takes a few days to fully reflect after redemption

Disclaimer: This article reflects tax rules and ITR form provisions as notified by the CBDT for AY 2026-27, current as of June 2026. Tax rules can change, and individual circumstances vary — this is general education, not personalised tax advice. Please consult a SEBI-registered investment advisor or a practising Chartered Accountant before filing your return or making investment decisions based on this article.

Sources: Income Tax Department — Return Applicability and AIS guidance  *  Income Tax Department — Response to Defective Notice 139(9) FAQs  *  AMFI — Tax Regime for Mutual Funds  *  CBDT Notification on revised ITR-2 for AY 2026-27 (30 March 2026)

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