Capital Gain
Definition
A capital gain is the profit realized when an investment is sold for more than its original purchase price.
Detailed Explanation
Capital gains occur when an investor sells a capital asset—such as stocks, real estate, or mutual funds—for more than the original purchase price. The gain is the difference between the selling price and the cost basis (usually the purchase price plus any associated fees). These gains are a key component of investing returns and are subject to taxation depending on how long the asset was held before the sale.
There are two types of capital gains: short-term and long-term. Short-term capital gains apply to assets held for one year or less and are taxed as ordinary income, often at a higher rate. Long-term capital gains, applied to assets held for more than one year, are typically taxed at lower, preferential rates (0%, 15%, or 20%, depending on income level). This tax distinction encourages long-term investing.
Capital gains are realized only when an asset is sold. Until that point, any increase in value is considered an unrealized gain and is not taxable. Investors often manage their portfolios with capital gains in mind, sometimes delaying sales to take advantage of favorable long-term tax treatment or to offset gains with losses (tax-loss harvesting).
Understanding capital gains is important for managing investment income, planning tax strategies, and evaluating overall portfolio performance.
Example
An investor buys 100 shares of stock at $50 per share for $5,000. Two years later, they sell the shares at $70 each for $7,000. The $2,000 difference is a long-term capital gain.
Key Articles Related To Capital Gains
Related Terms
Capital Loss: A loss realized when an asset is sold for less than its purchase price.
Cost Basis: The original value of an asset, used to calculate capital gains or losses.
Holding Period: The length of time an asset is owned before being sold.
Long-Term Capital Gain: Profit from the sale of an asset held for more than one year, typically taxed at reduced rates.
Portfolio: A collection of investments held by an individual or institution.
Short-Term Capital Gain: Profit from selling an asset held for one year or less, taxed at ordinary income rates.
Tax-Loss Harvesting: A strategy of selling investments at a loss to offset capital gains and reduce tax liability.
Unrealized Gain: A paper gain on an asset that has increased in value but has not yet been sold.
FAQs
Are capital gains always taxable?
Most capital gains are taxable, but exemptions and reduced rates may apply depending on the asset, holding period, and income level.
How are capital gains reported to the IRS?
Gains must be reported on your federal tax return, usually using IRS Form 8949 and Schedule D.
Do I pay taxes on unrealized gains?
No, taxes apply only when gains are realized through a sale.
How can I reduce capital gains tax?
Hold assets for more than one year, use tax-advantaged accounts, and consider tax-loss harvesting strategies.
Do dividends count as capital gains?
No, dividends are separate and taxed differently, although both are forms of investment income.
Editor: Colin Graves