What is a Capital Gain?
A capital gain is an increase in the value of an asset or investment resulting from the price appreciation of the asset or investment. In other words, the gain occurs when the current or sale price of an asset or investment exceeds its purchase price. Capital gains are attributable to all types of capital assets, including, but not limited to, stocks, bonds, goodwill, and real estate.
Classifications of Capital Gain
Capital gain can be realized or unrealized. The realized gain is the gain from the final sale of an asset or investment. Conversely, an unrealized gain arises when the current price of an asset or investment exceeds its purchase price, but the asset or investment is still unsold. Note that only realized capital gains are taxed, while unrealized (capital) gains are merely paper gains that are usually subject to accounting reporting but do not trigger a taxable event.
Additionally, realized capital gains are usually classified as short-term gains or long-term gains. Short-term (capital) gains occur if an asset or investment was held for less than a year. Long-term (capital) gains are gains from an asset or investment that was held for more than one year.
Capital Gains and Taxation
Realized capital gains are considered taxable events. Most countries impose special taxes for realized gains, levied on both individuals and corporations.
However, for the gains of investment funds such as a mutual fund, the tax on the gains is imposed upon the fund’s investors.
Generally, the holding time of an asset or investment affects the tax rate applicable to a capital gain. For example, if the gain is short-term (as defined above), it is taxed at the ordinary income tax rate. On the other hand, long-term (capital) gains are usually taxed at a lower tax rate. For example, if the ordinary tax rate is 35%, the capital gain can be taxed at a 20% rate.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: