Capital Gain

What is a Capital Gain?

A capital gain occurs when you sell an asset for a price higher than its original purchase price or cost basis. This profit is realized upon the sale of the asset.

Key Concepts

• Cost Basis: The original price paid for an asset, including commissions and fees.
• Realized Gain: Profit that becomes taxable when an asset is sold.
• Unrealized Gain: Profit on an asset that is still held; not yet taxable.
• Short-Term vs. Long-Term: Gains are categorized based on holding period (usually one year or less for short-term).

Deep Dive

The calculation of a capital gain involves subtracting the cost basis from the selling price. Different assets, such as stocks, real estate, and collectibles, have specific rules regarding their cost basis and how gains are calculated. The holding period is critical, as it determines whether the gain is short-term or long-term, affecting the tax rate applied.

Applications

Understanding capital gains is essential for investment strategy and tax planning. Investors aim to maximize long-term capital gains, which are often taxed at lower rates than ordinary income. It also influences decisions on when to buy and sell assets to optimize after-tax returns.

Challenges & Misconceptions

A common misconception is that an unrealized gain is taxable. Another challenge is accurately tracking the cost basis, especially with dividend reinvestments or stock splits. The distinction between short-term and long-term gains and their respective tax implications can also be confusing.

FAQs

Q: What is the difference between a capital gain and income?
A: Capital gains are profits from selling assets, while income is typically earnings from employment or business. Tax treatment often differs.

Q: Are all capital gains taxed?
A: Only realized capital gains (from selling assets) are subject to taxation.