capital gain

n.
The amount by which proceeds from the sale of a capital asset exceed the original cost.

1. An increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. A capital gain may be short term (one year or less) or long term (more than one year) and must be claimed on income taxes. A capital loss is incurred when there is a decrease in the capital asset value compared to its purchase price.

2. Profit that results when the price of a security held by a mutual fund rises above its purchase price and the security is sold (realized gain). If the security continues to be held, the gain is unrealized. A capital loss would occur when the opposite takes place

Investopedia Says:
1. Long-term capital gains are usually taxed at a lower rate than regular income. This is done to encourage entrepreneurship and investment in the economy.

2. Tax conscious mutual fund investors should determine a mutual fund's unrealized accumulated capital gains, which are expressed as a percentage of its net assets, before investing in a fund with a significant unrealized capital gain component. This circumstance is referred to as a fund's capital gains exposure. When distributed by a fund, capital gains are a taxable obligation for the fund's investors.

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Difference between an asset's adjusted purchase price and selling price when the difference is positive. A long-term capital gain is achieved once an asset such as a stock, bond, or mutual fund has been held for more than 12 months. Such long-term gains are taxed at a maximum rate of 15%. Those in the 15% tax bracket pay a 5% tax on long-term capital gains. Selling assets for a profit after holding them for 12 months or less generates short-term capital gains, which are subject to regular income tax rates. Assets purchased starting January 1, 2000 and held for more than five years qualify for a maximum capital gains tax rate of 8%. Capital gains are reported on Schedule D of a tax return.

Excess of the sales price of an asset over its book value. Listed as part of the Annual Report in the summary of the surplus account and/or in the Summary of Operations.

Difference between selling price of an asset and its cost when purchased. If the difference is positive, a gain is realized; if negative, a loss results. Long-term capital gains are taxed a maximum rate of 20% for taxpayers in the 28% tax bracket or higher, and at 15% for those in the 15% tax bracket, according to the 1997 Taxpayer Relief Act. Assets purchased after January 1, 2000 and held at least five years qualify for a maximum capital gain tax of 18% for those in the 28% tax bracket, and 8% for those in the 15% tax bracket.

Gain on the sale of a Capital Asset. Beginning May 6, 2003, the maximum individual tax rate on long-term capital gains is 15%. Deduction of Capital Losses against ordinary income is limited.
Example: Collins purchases land, for investment purposes, for $100,000. Some 13 months later she sells it for $140,000. She reports the $40,000 profit as a long-term capital gain on her income tax return.

A capital gain or loss results from the sale, trade, or exchange of a capital asset. Simply stated, when the resulting transaction nets an amount lower than the original purchase value, or basis, of the capital asset, a capital loss occurs. When the resulting transaction nets an amount greater than the basis, a capital gain occurs. Capital gains and losses can either be short-term (when the transaction is completed within one year) or long-term (when the transaction is completed in more than one year). The period is determined from the day after acquisition of the asset to the day of its disposal. Capital gain/loss is a concept that affects small business owners in a number of ways—from the decisions they must make regarding their personal property and investments to the attractiveness of their businesses to outside investors. The factors relevant to capital gain/loss are the capital asset, the transactional event, and time.

The subject of capital gain/loss causes much debate in government and economic circles. The current philosophy centers on the benefits and efficiencies of capital accumulation and utilization. To encourage capital formation and investment, the federal tax codes tax capital gains at lower rates than ordinary income. In 1997, the maximum tax rate on a long-term capital gain was lowered from 28 percent to 20 percent (compared to maximum income tax rates of 31 percent, 36 percent, and 39.6 percent). A lower capital gains tax is supposed to encourage people to sell stock and other assets, which increases the government's tax revenues. In the past, it has also had a beneficial effect on investment in small businesses, as they tend to provide investors with income via an appreciation in stock price (which is taxed as a capital gain) rather than via dividends (which are taxed as ordinary income).

Capital Assets

Everything one owns for personal use, pleasure, or investment is a capital asset. These include: securities, a residence, household furnishings, a personal car, coin and stamp collections, gems and jewelry, and precious metals. Since property held for personal use is considered a capital asset, the sale or exchange of that property at a price above the basis thus results in a capital gain, which is taxable. If one incurs a loss on that property from a sale or exchange, however, the loss cannot be deducted unless it resulted from a personal casualty loss, such as fire, flood, or hurricane. Other types of property and investments also have some irregularities in their treatment as capital gains or losses for tax purposes.

INVESTMENT PROPERTY, COLLECTIBLES, PRECIOUS METALS, AND GEMS. All investment property is also considered a capital asset. Therefore, any gain or loss is generally a capital gain or loss, but only when it is realized—that is, upon completion of the sales transaction. For example, a person who owns stock in a growing technology company may see the price of that stock appreciate considerably over time. For a gain to be realized, however, the investor must actually sell shares at a market price higher than their original purchase price (or lower, in the case of a capital loss). Section 1244 of the federal revenue code treats losses on certain small business stocks differently. If a loss is realized, the investor can deduct the amount as an ordinary loss, while he or she must report any gain as a capital gain.

SALE OF A HOME. The sale of a personal residence enjoys special tax treatment in order to minimize the impact of long-term inflation. For most people, a residence is the largest asset they own. While some appreciation is expected, residences are not primarily used as investment vehicles. Inflation may cause the value of a home to increase substantially while the constant-dollar value may increase very little. In addition, the growth in family size may encourage a family to step up to a larger home. To minimize the impact of inflation and to subsidize the purchase of new homes, the tax code does not require reporting a capital gain if the individual purchases a more expensive house within two years. In addition, individuals are entitled to exclude for tax purposes up to $250,000 and married couples up to $500,000 of capital gains from the sale of a home, provided they have lived in the home as a principal residence in two out of the previous five years. As of 2000, this exclusion was available to taxpayers every two years.

Determining the Basis

Capital gain/loss is calculated on the cost basis, which is the amount of cash and debt obligation used to pay for a property, along with the fair market value of other property or services the purchaser provided in the transaction. The purchase price of a property may also include the following charges and fees, which are added to the basis to arrive at the adjusted basis:

1. Sales tax.
2. Freight charges.
3. Installment and testing fees.
4. Excise taxes.
5. Legal and accounting fees that are capitalized rather than expensed.
6. Revenue stamps.
7. Recording fees.
8. Real estate taxes where applicable.
9. Settlement fees in real estate transactions.

The basis may be increased by the value of capital improvements, assessments for site improvements (such as the public infrastructure), and the restoration of damaged property. A basis is reduced by transactional events that recoup part of the original purchase price through tax savings, tax credits, and other transactions. These include depreciation, nontaxable corporate distributions, various environmental and energy credits, reimbursed casualty or theft losses, and the sale of an easement. After adjusting the basis for these various factors, the individual subtracts the adjusted basis from the net proceeds of the sale to determine gain/loss.

Net Gain or Loss

To calculate the net gain/loss, the individual first determines the long-term gain/loss and short-term gain/loss separately. The net short-term gain/loss is the difference between short-term gains and short-term losses. Likewise, this difference on a long-term basis is the net long-term gain/loss. If the individual's total capital gain is more than the total capital loss, the excess is taxable generally at the same rate as the ordinary income. However, the part of the capital gain which is the same amount as the net capital gain is taxed only at the capital gains tax rate, maximum 20 percent. If the individual's capital losses are more than the total capital gains, the excess is deductible up to $3,000 per year from ordinary income. The remaining loss is carried forward and deducted at a rate up to $3,000 until the entire capital loss is written off.

Further Reading:

Dixon, Daryl. "Gaining on the Capital Gains Tax." The Bulletin with Newsweek. April 13, 1999.

Dixon, Daryl. "Two for the Money: Plans to Reduce Taxes on Capital Gains." The Bulletin with Newsweek. June 22, 1999.

Internal Revenue Service. Tax Guide for Small Business. Department of the Treasury, 1995.

Kadlec, Daniel. "Capital Gain Market Pain?" Time. August 18, 1997.

Santoli, Michael. "Profiting from Losses: These Tax Moves Can Help You Play Scrooge to the IRS." Barron's. December 6, 1999.

Personal income earned by the sale of assets, such as stocks or real property. The gain is the difference between the price paid for the asset and the selling price. Most conservatives want capital gains taxed at a lower rate than ordinary income in order to stimulate investment, whereas most liberals oppose a lower rate for capital gains as a subsidy for the wealthy.

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