Capital Gain

Capital gain refers to a measured increase in the value of an asset or investment which causes its worth to become higher than its original purchase price (the basis). The gain on a capital asset or capital investment is unrealised until its sale. Capital gain maybe short term, spanning a period of one year or less. It can also be long term i.e. one year and more.

Capital gains are generally connected with stocks and funds as a result of their unique price instability. However, a capital gain can take place on any security sold at a higher price than the paid purchase price. Capital gains are made when capital property is sold for more than its initial purchase price, and for less than all legitimate expenses associated with its sale.

Capital gains and losses which are realised occur after the sale of an asset triggers a taxable event. An increase or a decrease in the value of an investment is reflected by unrealised gain and losses, also known as paper gains and losses. However, they have not yet offset a taxable event.

How Capital Gain is Taxed

The tax on capital gains is not the same as marginal tax rate. Only half of the percentage of capital gain on a specific sale is taxed. A capital gain of $30,000 for example, would only be taxed half or $15,000 is what is taxable from the total amount. The balance would be for the investor to keep for himself or herself.

Capital gains and losses are classified as long term or short term based on the length of time for which the asset was held. Long term refers to assets held for more than a year, and short term for assets held for less than that time.

Taxpayers who fall in the 10 – 15% tax brackets do not pay tax on long term profits on most assets while a 15% rate is placed on long term capital gains for individuals in 25 to 35% income tax brackets. In addition, there is a 20% rate for those with income tax brackets of 39% and up. However, short term capital gains are taxed at the same rate as ordinary income.

How Capital Gain is calculated

Capital gain is calculated taking initial stock price and stock price after the first period into account. This method is used to calculate the return on a stock based only on how much the specific stock increases in value. Calculating the capital gains yield is basically calculating the rate of change recorded by the stock price.

In calculating capital gain, some of the factors to be considered include:

  • Method of acquisition of asset (from a deceased person, as a result of breakdown of a marriage or other relationship, and so on).
  • Duration of ownership (when the asset was acquired and when it was disposed, if the asset is a rollover asset, if the asset was disposed of less than 12 months after the death of its original owner)

The formula used to calculate capital gains yield uses the rate of change formula. To get rate of change, an ending amount is subtracted from the original amount, which is then divided by the original amount. Dividends paid on the stock are not included in the calculations for capital gains. Total stock return is gotten by combining the capital gains yield and dividend yield.

What is Capital Gain Distribution?

Capital gain distribution refers to the payment made to shareholders, prompted by the liquidation of a fund manager’s hidden stocks and securities invested in a mutual fund, or gotten from interests and dividends earned from the fund’s holdings without its operating expenses. According to the law, substantial portions of income from investment and capital gains must be paid to investors. Therefore, a mutual fund manager must distribute the capital gains.

Individuals receiving the distributions are taxed at capital gains rates according to their distributions. Capital gains tax are required to be paid on any capital gains distributions made by personal funds. In the past, long term capital gains were taxed regardless of the length of time they were held for. Now, the duration of the fund is considered in determining long or short term capital gains tax.

Effects of Capital Gains and Losses on Tax

Fund investors are obliged to pay taxes on capital gains distributed by a fund. A mutual fund’s latent accumulated capital gains are shown as a percentage of its net assets, and should be determined by tax-conscious investors, before investing in a fund with the component of significant unrealized capital gain.

Short-term capital gains are realized from securities that are held for at least one year. Such gains are taxed as ordinary income, according to the tax filing status of the individual and adjusted gross income. While most tax payers qualify for a 15% long term capital gains tax rate, taxpayers who fall within 10 to 15% tax brackets would pay zero percentage in long term capital gains tax rate.

How to Legally Hold on to More Capital Gains

To hold on to a higher amount of capital gains, capital gains tax needs to be reduced or avoided. This can be done in different ways, each one in line with the law:

Capital losses from other investments can be used to offset capital gains. In cases where taxable capital gains are unavailable, a capital loss cannot be claimed against normal income except in certain small business corporations.

Capital gains tax does not apply to the sale of a principal residence. Specific rules apply to property such as income properties, vacation homes and other types of physical property where capital gains tax is concerned.

Financial donations in form of securities to private foundations are not liable to capital gain. The same holds true for securities donated to registered charities as well.

When an asset is sold for capital gain but the money cannot be collected right away for one reason or the other, the individual might be able to claim a reserve or in other cases, could defer collection of the capital gain until a later time.

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Published on 14th June 2017

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