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What is Capital Gains Tax?
Capital Gains Tax (CGT) is a tax imposed on the profit earned from selling a capital asset (such as stocks, real estate, or a business) when the selling price exceeds the original purchase price. The tax applies only to the gain, not the total sale amount.
Definition
Capital Gains Tax is a tax on the profit realized from the sale of a capital asset.
Key Takeaways
- Applies to profits from selling assets like property, investments, or businesses.
- Tax is due only when the gain is realized (the asset is sold).
- Long-term gains often receive lower tax rates than short-term gains.
Understanding Capital Gains Tax
Capital gains occur when an asset is sold for more than its original cost. CGT is designed to tax that profit. The tax treatment depends on:
- Holding period: Long-term (favorable rates) vs. short-term (higher rates)
- Asset type: Real estate, investments, collectibles, business assets
- Local tax laws: Rates and exemptions vary by country
Many tax systems encourage long-term investing by taxing long-term gains at lower rates. Losses on asset sales can sometimes offset gains, reducing tax liability.
Formula (If Applicable)
Capital Gain = Selling Price − Adjusted Basis
Capital Gains Tax = Capital Gain × Applicable Tax Rate
Adjusted basis includes purchase price plus improvements minus depreciation (where applicable).
Real-World Example
An investor buys shares for $5,000 and sells them for $8,000.
Capital Gain = 8,000 − 5,000 = $3,000
If the long-term CGT rate is 15%:
Capital Gains Tax = 3,000 × 0.15 = $450
Importance in Business or Economics
CGT influences:
- Investment decisions
- Real estate turnover
- Entrepreneurship and business sales
- Portfolio management
High CGT rates can discourage selling or reinvesting, while lower rates may encourage more trading and capital mobility.
Types or Variations
- Short-Term Capital Gains: Taxed at higher rates; holding period typically under one year.
- Long-Term Capital Gains: Lower tax rates; rewards patient investment.
- Exemptions and Reliefs: Vary by jurisdiction (e.g., primary residence exclusions).
Related Terms
- Capital Gain
- Adjusted Basis
- Taxable Income
Sources and Further Reading
- IRS Capital Gains Tax Guide: https://irs.gov
- OECD Tax Policy Studies: https://oecd.org
- Investopedia: https://investopedia.com
Quick Reference
- CGT taxes profit from selling capital assets.
- Long-term gains usually taxed at lower rates.
- Gain = Selling price minus adjusted basis.
Frequently Asked Questions (FAQs)
Do I pay CGT if I don’t sell the asset?
No. CGT applies only when gains are realized through a sale.
Are all assets subject to CGT?
Most are, but many countries exempt primary residences, retirement accounts, or certain business assets.
Can capital losses reduce tax owed?
Yes. Losses may offset gains and sometimes reduce taxable income.
