Capital Gains

A capital gain refers to profit that results from a sale of a capital asset, such as stock, bond or real estate, where the sale price exceeds the purchase price. The gain is the difference between a higher selling price and a lower purchase price. Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price.

Capital gains may also refer to a different form of profit received from an asset which refers to “investment income” in the form of cash flow or passive income that arises in relation to real assets, such as property; financial assets, such as shares/stocks or bonds; and intangible assets.

Capital gain is 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 an asset’s purchase price.

While capital gains are generally associated with stocks and funds due to their inherent price volatility, a capital gain can occur on any security that is sold for a price higher than the purchase price that was paid for it. Realized capital gains and losses occur when an asset is sold and triggers a taxable event. Unrealized gains and losses, sometimes referred to as paper gains and losses, reflect an increase or decrease in an investment’s value but have not yet triggered a taxable event.

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.

Short-term capital gains occur on securities held for one year or less. These gains are taxed as ordinary income based on the individual’s tax filing status and adjusted gross income. Long-term capital gains are usually taxed at a lower rate than regular income. The long-term capital gains rate is 20% in the highest tax bracket. Most taxpayers qualify for a 15% long-term capital gains tax rate. However, taxpayers in the 10% and 15% tax brackets would pay a 0% long-term capital gains tax rate.

Mutual funds that have accumulated realized capital gains throughout the course of the year must distribute those gains to shareholders. Many mutual funds distribute capital gains right before the end of the calendar year.

Shareholders of record as of the fund’s ex-dividend date receive the fund’s capital gains distribution. Individuals receiving the distribution get a 1099-DIV form detailing the amount of the capital gain distribution and how much is considered short-term and long-term. When a mutual fund makes a capital gain or dividend distribution, the net asset value (NAV) drops by the amount of the distribution. A capital gains distribution does not impact the fund’s total return.

Capital gains or losses are not counted during national income accounting as they only pertain to transference of rights to shares and assets and hence do not correspond to any new production activity.

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