Capital Gain
Definition
A capital gain is the profit earned from the sale of a capital asset, including real estate, stocks, bonds, and other properties. The gain is calculated as the difference between the sale price of the asset and its purchase price. Capital gains can be classified as either short-term or long-term, each subjected to different tax rates.
Examples
- Real Estate Investment: John buys a rental property for $250,000. After owning it for 5 years, he sells it for $350,000. The $100,000 profit from the sale is classified as a long-term capital gain.
- Stocks: Emily purchases 100 shares of a tech company at $15 per share, totaling $1,500. Two years later, she sells them at $25 per share, earning a total of $2,500. The profit of $1,000 is reported as a long-term capital gain.
- Bonds: Michael buys bonds for $20,000 and sells them after 6 months for $22,000. The $2,000 profit is treated as a short-term capital gain.
Frequently Asked Questions
Q1: What is the difference between short-term and long-term capital gains? A1: Short-term capital gains are profits from the sale of assets held for one year or less and are taxed at ordinary income tax rates. Long-term capital gains are profits from assets held for more than one year and are taxed at preferential rates.
Q2: How is a capital gain taxed? A2: Long-term capital gains are taxed at reduced rates of 0%, 15%, or 20%, depending on the taxpayer’s income. Short-term capital gains are taxed at the individual’s regular income tax rate.
Q3: Can capital losses be deducted? A3: Yes, capital losses can be deducted against capital gains. If capital losses exceed capital gains, up to $3,000 per year can be deducted against ordinary income, with excess losses carried forward to future years.
Q4: What is Section 121? A4: Section 121 of the Internal Revenue Code allows homeowners to exclude up to $250,000 ($500,000 for married couples) of capital gains from the sale of their primary residence, provided they have lived in the home for at least two of the five years preceding the sale.
Related Terms with Definitions
- Capital Asset: Assets of a permanent nature used in the operation of a business or held for investment, such as stocks, bonds, and real estate.
- Capital Loss: The loss incurred when a capital asset is sold for less than its purchase price.
- Section 121 Exclusion: A tax exemption that allows the exclusion of up to $250,000 ($500,000 for married couples) of capital gains on the sale of a primary residence.
- Tax Basis: The original cost of an asset, used to determine capital gain or loss upon sale.
Online Resources
- IRS Topic No. 409 — Capital Gains and Losses: Detailed information about how the IRS handles capital gains and losses.
- Capital Gains Tax 2023 (Investopedia): Comprehensive guide on capital gains tax.
- Kiplinger’s Tax Guide for Investors: Expert advice related to taxes on investments, including capital gains.
References
- U.S. Internal Revenue Service. “Topic No. 409 - Capital Gains and Losses.” IRS.
- Investopedia. “Capital Gains Tax.” Investopedia.
Suggested Books for Further Studies
- Rich Dad’s Guide to Investing by Robert T. Kiyosaki and Sharon L. Lechter – An in-depth exploration of investment strategies including real estate.
- The Real Estate Investor’s Tax Guide by Vernon Hoven – Practical insights into understanding tax implications for real estate investors.
- Principles of Real Estate Practice by Stephen Mettling and David Cusic – A comprehensive resource on real estate fundamentals and tax considerations.
Real Estate Basics: Capital Gain Fundamentals Quiz
### How is a short-term capital gain classified for tax purposes?
- [ ] As exempt income.
- [x] As ordinary income.
- [ ] As interest income.
- [ ] As deferred income.
> **Explanation:** Short-term capital gains are treated as ordinary income and taxed at the individual's standard income tax rate.
### What determines whether a capital gain is short-term or long-term?
- [ ] The market value at which the asset is sold.
- [ ] The type of asset sold.
- [x] The duration for which the asset was held.
- [ ] The seller's tax bracket.
> **Explanation:** The classification of a capital gain as short-term or long-term depends on how long the asset was held before being sold. Assets held for one year or less qualify as short-term, while those held for more than one year qualify as long-term.
### Which section of the Internal Revenue Code allows for the exclusion of gains from the sale of a primary residence?
- [ ] Section 1031
- [x] Section 121
- [ ] Section 4797
- [ ] Section 1060
> **Explanation:** Section 121 allows homeowners to exclude up to $250,000 ($500,000 for married couples) of capital gains from the sale of their primary residence, subject to certain conditions.
### What happens to capital losses that exceed capital gains in a year?
- [ ] They are completely wasted and cannot be used.
- [ ] They must be written off immediately.
- [x] They can be deducted up to $3,000 per year and carried forward.
- [ ] They convert to short-term losses.
> **Explanation:** If capital losses exceed capital gains, up to $3,000 per year can be deducted against ordinary income, and any remaining losses can be carried forward to future years.
### What rate are long-term capital gains typically taxed at?
- [x] Preferential rates (0%, 15%, or 20%)
- [ ] Ordinary income rates
- [ ] Corporate tax rates
- [ ] Passive income rates
> **Explanation:** Long-term capital gains are taxed at preferential rates of 0%, 15%, or 20%, depending on the taxpayer's income.
### Which type of assets can result in a capital gain?
- [ ] Passive activities only
- [ ] Transient goods only
- [ ] Depreciable business equipment only
- [x] Capital assets such as real estate and stocks
> **Explanation:** Capital gains can result from the sale of capital assets, which include real estate, stocks, bonds, and other investment properties.
### What must occur for a gain to be considered 'realized'?
- [x] The asset must be sold.
- [ ] The asset must be revalued.
- [ ] A financial statement change must occur.
- [ ] A tax return must be filed.
> **Explanation:** A gain is considered realized when the capital asset is sold and the profit or loss is crystallized.
### Are capital gains from the sale of a personal car subject to capital gains tax?
- [ ] Yes, always
- [ ] Only if used for business purposes
- [ ] Only if the car meets certain mileage
- [x] No, personal use items like private cars do not generate capital gains.
> **Explanation:** Personal use items, like a private car, do not generate capital gains even if sold at a profit.
### Can capital gains be offset by capital losses?
- [x] Yes, capital losses can directly offset capital gains.
- [ ] No, they must be treated separately.
- [ ] Only if the capital loss is higher than the gain.
- [ ] Only in the year they are both realized.
> **Explanation:** Capital losses can be used to offset capital gains, which helps in reducing the taxable gain.
### How often can you claim the Section 121 exclusion on the sale of a primary residence?
- [ ] Once every year
- [ ] Once every six months
- [x] Once every two years
- [ ] As frequently as residences are sold
> **Explanation:** The Section 121 exclusion can be claimed once every two years for the sale of a primary residence, provided the homeowner meets the criteria.
