A client needs Rs 25 lakh and holds three equity funds in which gains are 10%, 45% and 70% of current value. Which does she redeem to pay the least tax, and how much less does she pay?

Redeem from Fund A: the tax is Rs 31,250 against Rs 2,18,750 from Fund C, a saving of Rs 1,87,500. Tax is charged on the gain inside each rupee redeemed. In Fund A only 10 paise in every rupee is gain, so Rs 25 lakh realises Rs 2.5 lakh of gain; in Fund C it realises Rs 17.5 lakh. Check the unit-level gains and what the sale does to her allocation first.

When you sell an old car, the tax question is not what you sold it for but how much more that was than you paid. Each rupee redeemed from a fund is part original money and part gain, and only the gain part is taxed. Fund A's rupee is 90 paise of her own money and 10 paise of gain; Fund C's is 30 paise and 70 paise. The same withdrawal carries seven times as much taxable gain from C as from A.

Be honest about what this is. The gain in Fund C is not forgiven; it is deferred until she sells C, which may be many years away or may pass to her heirs. Deferral still has value: the Rs 1,87,500 stays invested and compounds. At an assumed 10% a year for ten years it grows to about Rs 4,86,327. That is the real prize of choosing the right fund to sell, and it costs nothing but attention.

Three things. First, first in, first outThe rule that the oldest units in a folio are treated as sold first, so the gain realised depends on those units, not on the fund average.: the units sold first are the oldest, which usually carry the largest gains, so the gain in the redemption can be higher than the fund's average. Ask for the unit-level statement. Second, if any of Fund A's units were bought within the last year, they are short-term, and at an illustrative 20% the tax on them would be Rs 50,000, still the cheapest option here. Third, taking Rs 25 lakh out of A leaves only Rs 5 lakh in it; if A was her diversifier, the allocation needs a look.

Close with the rule the interviewer wants to hear. When cash is needed, redeem where the gain share is lowest, then check the unit-level gains and the allocation before placing the order. The limit: if Fund A is the fund she most wants to keep, a small extra tax may be the right price for holding the better portfolio.