Problem 16 What is a capital gain?... [FREE SOLUTION]

Chapter 17: Problem 16

What is a capital gain?

Short Answer

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A capital gain is the increase in value of an investment or security, such as stocks, bonds, or real estate, over its purchase price. It is realized when the asset is sold, and the profit made from the sale is considered a capital gain. Capital gains can be classified as short-term or long-term depending on the holding period of the investment. To calculate the capital gain, subtract the purchase price of the asset from its current market price or the selling price (Capital Gain = Selling Price - Purchase Price). Short-term capital gains are generally taxed at a higher rate than long-term capital gains to encourage long-term investments.

Step by step solution

Understand the concept of capital gain

A capital gain refers to the increase in value of an investment or a security (such as stocks, bonds, or real estate) over its purchase price. It is generally realized when the asset is sold, and the profit made from the sale is considered a capital gain. Capital gains can be classified as short-term or long-term depending on the holding period of the investment (usually less than one year for short-term and more than one year for long-term).

Learn about capital gain calculation

To calculate the capital gain, subtract the purchase price of the asset from its current market price or the selling price. The resulting value is the capital gain. Capital Gain = Selling Price - Purchase Price

Understand the differences between short-term and long-term capital gains

Short-term capital gains are generally taxed at a higher rate than long-term capital gains. This is because the government wants to encourage long-term investments, which are considered more stable and beneficial to the economy. The tax rate for short-term capital gains is often the same as the investor's ordinary income tax rate, while long-term capital gains are usually taxed at a lower rate.

Example of capital gain

Let's consider an example to help you better understand capital gains. If an investor bought 100 shares of a stock at $10 per share (total purchase price of $1,000) and later sold them for $12 per share (total selling price of $1,200), we can calculate the capital gain as follows: Capital Gain = Selling Price - Purchase Price Capital Gain = $1,200 - $1,000 Capital Gain = $200 In this example, the investor has made a capital gain of $200. Depending on how long they held the stock before selling, this capital gain might be classified as short-term or long-term and taxed accordingly.