Question

What is a capital gain?

Short answer

A capital gain is the increase in the value of an investment or asset, such as shares of stock, real estate, or other valuable items, when the current value or selling price is higher than the original purchase price. Capital gains can be categorized into short-term (held for a year or less) and long-term gains (held for more than a year), with different tax rates applied. For example, if an investor purchases 100 shares at $20 each and later sells them at $30 each, the capital gain is $1,000, and if held for more than a year, it is considered a long-term capital gain.

Step-by-step solution

Defining Capital Gain

A capital gain is the increase in the value of an investment or asset, such as shares of stock, real estate, or other valuable items. It occurs when the current value or selling price of the asset is higher than the original purchase price at which the investor acquired the asset. Consequently, the investor realizes a profit from the sale of the asset. It's important to note that a capital gain is only realized once the asset is actually sold for more than the initial cost.

Types of Capital Gains

Capital gains can be broadly categorized into two types: short-term capital gains and long-term capital gains. Short-term capital gains are those realized from the sale of an asset held for a year or less. These gains are typically taxed at a higher rate than long-term capital gains, which are gained from the sale of assets held for more than a year. Long-term capital gains tax rates vary depending on the income level of the investor and are generally more favorable than short-term capital gains tax rates.

Example of a Capital Gain

To better illustrate the concept of capital gain, here's a straightforward example: Suppose an investor purchases 100 shares of a certain company's stock at a price of $20 per share. The total cost of this purchase is \(100 \times 20 = \$2,000\). After two years, the value of each share increases to $30. The investor decides to sell all 100 shares at this new price. The total amount received from the sale is \(100 \times 30 = \$3,000\). In this case, the capital gain is the difference between the initial purchase price of the shares (\$2,000) and the final selling price (\$3,000), which is \(\$3,000 - $2,000 = \$1,000\). Since the investor held the shares for more than a year, this would be considered a long-term capital gain and may be subject to a more favorable tax rate.