Capital Gain - Explained
What is a Capital Gain?
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Table of ContentsWhat is a Capital Gain?How do Capital Gains Work? Academic Research on Capital Gains
What is a Capital Gain?
A capital gain is the returns acquired from the disposing of assets. Capital gain is achieved when the selling price is higher than the buying price. However, there will be a loss when the buying price is higher than the selling price.
- Note: This section assumes the idea of asset depreciation.
From the definition, we find a series of notions that are worth analyzing.
Back to: ACCOUNTING, TAX, & REPORTING
How do Capital Gains Work?
We can obtain capital gains from the following assets:
- Financial assets: They include bonds, stocks, obligations, etc. Most capital gains are generated as a result of transactions between these financial assets.
- Real estate: Capital gains can also be generated from transactions in real estates like premises, homes, and plots.
Capital gain or loss is calculated by comparing the buying price and selling price which are never easy to evaluate. Generally, the buying price refers to the cost that an individual pay when for the asset and all the expenses necessary for the purchase to take place. Conversely, the sales price refers to the amount the seller receive from the buyer. In some cases, the IRS provides that certain assets be valued for their market value or pursuant to other criteria. As such, it is important to take into account the provision of the law in the valuation of an acquisition and the sale of the assets. When the asset is sold, capital gain is also realized and the sale materializes. Even though there has been an increase in the value of the shares, no gain occurs when the asset is not sold. Capital gains are based on two categories of taxation:
- Long-term Capital Gains - This is 0, 15, or 20%, which is based on an individual's tax bracket.
- Short-term Capital Gains It refers to an individual's regular income tax rate on the marginal dollars earned.
Academic Research on Capital Gains
- The effects of income, wealth, and capital gains taxation on risk-taking, Stiglitz, J. E. (1975). In Stochastic Optimization Models in Finance (pp. 291-311). This article studies the impacts of income, wealth and capital gains taxation on risk-taking. The author tries to explore the impact of no loss-offset provision in income tax. An increase in proportional wealth tax does not change or increases the demand for risky assets. This is because individuals have decreasing relative risk aversion. If there is a decreasing absolute and relative risk aversion, investments in the risky assets may reduce because of the imposition of income tax which discourages people.
- Some aspects of the taxation of capital gains, Stiglitz, J. E. (1983). Journal of Public Economics, 21(2), 257-294. This article looks into some of the aspects of the taxation of capital gains. The author raises some strategies that rational investors can use to avoid taxes on both their capital income and on their wage income. Any analysis of the impacts of capital taxation must concentrate on imperfect capital markets. Individuals should not have a limitation on what they can borrow because this will lead into a locked- in effect, meaning they will not be able to sell securities which they would have sold if the taxes were not there. In the presence of tax, individuals will be forced to sell the securities that they would have held to take advantage of the future market situation.
- Capital gains taxation and yearend stock market behavior, Dyl, E. A. (1977). The Journal of Finance, 32(1), 165-175. This section is trying to address the end of year stock market behavior and how it relates to capital gains.
- How burdensome are capital gains taxes?: Evidence from the United States, Poterba, J. M. (1987). Journal of Public Economics, 33(2), 157-172. This paper is concerned with how capital gains taxes burden individuals. Evidence from the United States indicates that taxpayers with capital gains or losses are faced with binding loss-offset. The author claims that most investors try to avoid capital gains tax because it weighs on them negatively.
- Capital gains versus current income in the farming sector, Melichar, E. (1979). Capital gains versus current income in the farming sector. American Journal of Agricultural Economics, 61(5), 1085-1092. This paper highlights to us the impact of capital gains on the current income in the farming sector.
- Venture capital and capital gains taxation, Poterba, J. M. (1989). Tax policy and the economy, 3, 47-67. This section highlights the relationship between the amount of venture capital activity and the capital gains taxation. It provides the basis for understanding how tax policy affects start-up firms.
- Capital gains tax rules, taxloss trading, and turnoftheyear returns, Poterba, J. M., & Weisbenner, S. J. (2001). The Journal of Finance, 56(1), 353-368. This article states that changes in the capital gains facing individual investors do not face institutional investors but they can affect incentives for the end of year individual investors tax-induced trading. In short, the author claims that there is a weak correlation between early year losses and end of year profits. Tax- loss trading leads to a turn of end year profits.
- Capitalization of capital gains taxes: Evidence from stock price reactions to the 1997 rate reduction, Lang, M. H., & Shackelford, D. A. (2000). Journal of Public Economics, 76(1), 69-85. This author in this article shows us how stock prices are indirectly proportional during the month of May 1997 in the US. The author found out that market value is enhanced by a reduction in capital gains and also when individuals hold stock.
- The effects of taxation on the selling of corporate stock and the realization of capital gains, Feldstein, M., Slemrod, J., & Yitzhaki, S. (1980). The Quarterly Journal of Economics, 94(4), 777-791. The author here tries to highlight to us the effect that taxation has on the realization of capital gains. It employs the study by Feldstein and Yitzhaki in its analysis. The finding agrees with the earlier research which states that corporate stock sales depend on the tax rates.
- Capital gains tax policy toward entrepreneurship, Poterba, J. M. (1989). National Tax Journal, 42(3), 375-389. This section is concerned with the influence of Capital gains on entrepreneurship.
- The impact of intellectual capital on investors' capital gains on shares: An empirical investigation of Thai banking, finance & insurance sector, Appuhami, B. R. (2007). International Management Review, 3(2), 14-25. The article is trying to find out how investors capital gains on shares relate to corporate value creation. This study was conducted in Thailand's stock market. The research established that a firms intellectual capital has a direct correlation with its investors capital gains on shares.