A capital gain is the profit one makes when selling a capital asset, where the sale price is greater than the purchase price. A capital asset could be a bond, stock or real estate.
It is the opposite of a capital loss, which occurs if the sale’s proceeds are lower than the capital asset’s purchase price.
The gain is only realized when the sale of the asset is concluded. If you have an asset that is now worth more than what you paid for it, but you have not sold it, there is no capital gain yet.
The term ‘capital gains’ refers to the investment income one gets from property, shares, bonds, and intangible assets.
Whenever you make a capital gain, you must make sure you let the tax authorities know.
Capital gains are taxable
Most countries across the world impose a tax on capital gains – called ‘capital gains tax’.
The UK Government says the following on its website regarding Capital Gains Tax:
“Capital Gains Tax is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive.”
As soon as it comes to selling your stocks, bonds, and other investments, if you have done well capital gains tax will come to haunt you.
Example of a capital gain
Imagine you purchased a painting for $100,000, and sold it one year later for $125,000. This means you made a capital gain of $25,000 ($125,000 minus $100,000).
In most countries, gifts to a spouse, a civil partner or a charity are not liable for capital gains tax. However, check with your tax authorities, because many gifts are taxable.
Definition of capital assets
While economists and businesses say capital assets are just those that are used to produce goods and deliver services, like machinery, equipment, vehicles, etc., most tax authorities, including the United States Internal Revenue Service (IRS), have a much wider definition for the term.
“Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments.”
Most countries’ tax authorities say capital gains and losses are classified into long- or short-term. If the asset has been held for over 12 months before it is sold, the capital gain is long-term. If it is held for one year or less, the capital gain or loss is short-term.
The Nasdaq Business Glossary says the following about capital gain:
“When a stock is sold for a profit, the capital gain is the difference between the net sales price of the securities and their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.”
Video – How capital gains tax works