Capital Gains

A capital gain refers to the appreciation in value of a capital asset at the time of its sale, wherein the asset is sold for a price higher than its purchase cost. A capital asset can be an investment, such as stocks, bonds, or real estate, or a personal item, like a boat or furniture. Subtracting the purchase cost from the sale price results in the realized capital gain. The IRS may impose capital gains taxes on individuals under specific circumstances.

Understanding Capital Gains

As mentioned earlier, capital gains represent the rise in value of an asset, which are frequently realized upon its sale. While capital gains are commonly associated with volatile investments such as stocks and funds, they can also be generated from the sale of any asset, such as a house, furniture, or car, that is sold at a price higher than its original purchase cost.

Capital Gains are classified into 2 types:

1. Short-term capital gains: Gains that you realize after selling assets that you've owned for no more than a year.
2. Long-term capital gains: Gains that you have accrued from selling assets that you have owned for more than a year.

Example of Capital Gains

Here is a fictitious scenario to illustrate how capital gains operate and are taxed. Say Jeff paid $350 per share on January 30, 2016, to buy 100 shares of Amazon (AMZN) stock. Then, on January 30, 2018, he decided to sell every stake for $833. In the event that there were no costs related to the transaction, Jeff earned a capital gain of $48,300 ($833 x 100 - $350 x 100 = $48,300).

Jeff makes $80,000 a year, which places him in the large income bracket that is eligible for the 15% long-term capital gains tax rate ($40,001 to $441,500 for individuals and $80,001 to $496,600 for those filing jointly).

Therefore, Jeff must pay $7,245 in taxes for this transaction ($48,300 x 0.15 = $7,245).

What Is Net Capital Gain?

According to the IRS, a net capital gain is the difference between a net short-term capital loss and a net long-term capital gain (long-term capital gains minus long-term capital losses plus any unused capital losses carried over from earlier years) (short-term capital gain minus short-term capital loss). A net capital gain may be taxed at a rate that is lower than the rate on ordinary income.

Conclusion

Capital gains are profits from the sale of an investment, such as stocks, bonds, or real estate. Because capital gains taxes are lower than regular income taxes, investors have an advantage over wage earners. Furthermore, one's overall tax liability may occasionally be reduced by capital losses.

For these reasons, an investor might benefit greatly from having a thorough understanding of capital gains taxes.

Key Takeaways

• The increase in value realized upon selling a capital asset is referred to as a capital gain.
• Capital gains taxes apply to all assets, including those purchased for personal use and investments.
• The gain, which must be reported on income taxes, may be short-term (lasting less than a year) or long-term (lasting more than a year).
• While reflecting an increase or reduction in an investment's value, unrealized gains and losses are not regarded as taxable capital gains.
• When a capital asset's value declines relative to its acquisition price, a capital loss is suffered.