Capital gain
In finance, a capital gain is profit that results from the appreciation of a capital asset over its purchase price. If the price of the capital asset has declined instead of appreciated, this is called a capital loss. Capital gains occur in both real assets, such as property, as well as financial assets, such as stocks or bonds.
U.S. tax ramifications
Under the United States Tax Code's section 1222, gain or loss from sale or exchange of a capital asset is a capital gain or loss. Per IRS Tax Topic 409, "Almost everything you own and use for personal or investment purposes is a capital asset. Examples are your home, household furnishings, and stocks or bonds held in your personal account." If a person sells a capital asset for more than he or she paid for it, the gain is taxable. However, for personal-use capital assets, such as a personal automobile, a capital loss is not deductible.
Long term vs. short term
Generally, appreciated capital assets that are sold by an individual after being held more than one year (long-term capital gain) will be taxed at a maximum rate of 15%. For the sale of collectibles and small business stock, the rate of taxation for individuals is a maximum of 28%. Appreciated capital assets that are sold by individuals after being held less than one year (short-term capital gain) will be taxed as ordinary income, which rises as high as 39.6% in the U.S. progressive tax system. [1] Capital gains by entities taxed as corporations do not receive preferential treatment, and are taxed at a maximum rate of 35 percent. [2]
Realized vs. unrealized
Capital gains can be either realized or unrealized. Realized capital gains occur when the actual sale or exchange of the asset returned more money than the purchase price (as adjusted for depreciation and other factors). Unrealized capital gains occur when it is known that the asset has appreciated in value, but the asset has not been sold yet; the gain is only potential.
In the United States, unrealized capital gains are not generally subject to income tax. There are, however, certain exceptions to this general rule. For example, dealers in securities are required to recognize income yearly on the appreciation of securities held as inventory. [3] Capital gains that are realized (and unrealized gains treated as realized under the special rules discussed above) are generally subject to tax, unless some provision of the code provides that those gains need not be currently recognized for tax purposes. Such provisions include, for example, an exclusion from gross income for the first $250,000 (or $500,000 in the case of married couples filing jointly) of capital gain realized on the sale of a principal residence. [4]
Capital loss offset
In taxation in the United States, capital gains are subject to capital gains tax, but if a taxpayer has suffered from capital losses in the same year, he can offset the gains with the losses to reduce his taxable income. If the losses exceed the gains, then up to $3,000 may be deducted to offset federal tax on ordinary income each year. According to IRS Publication 550 [1] if you have a total net loss that is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you had incurred it in that next year. When you carry over a loss, it remains long term or short term. A long-term capital loss you carry over to the next tax year will reduce that year's long-term capital gains before it reduces that year's short-term capital gains. Thus any remaining capital loss may be "Carried Forward" to the next year and claimed as a capital loss against both capital gains and up to $3,000 against income on that year's tax return etc. If part of the loss is still unused, you can carry it over to later years until it is completely used up, or until the death of the individual who incurred the loss.
Sale of principal residence
A capital gain on the sale of a principal residence is afforded special treatment for Federal income tax purposes. Married sellers of a principal residence may generally exclude up to $500,000 of gain ($250,000 of gain in the case of single individuals) from gross income, provided the real estate was used as the sellers' primary residence for at least two years during the five year period ending with the date of the sale.
Other Countries where Capital Gains are taxable
In India, long term Capital Gains is taxed at 10% (if no indexation of cost price is done). However if the person opts to apply indexation to the cost price (as per Government rules), the tax rate will be 20%.
Short term Capital Gains is added to the normal income and taxed at the same rate as applicable for the person.
Notes
References
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- For further information on U.S. capital gains, go to Tax Topic 409 at the IRS: http://www.irs.gov/taxtopics/tc409.html and Publication 550 at http://www.irs.gov/publications/p550/ch04.html#d0e11041
- List of Tax Havens