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Capital Appreciation – Definition & Explanation

Cite this article as: Jason Mance Gordon, "Capital Appreciation – Definition & Explanation," in The Business Professor, updated January 18, 2019, last accessed April 10, 2020, https://thebusinessprofessor.com/knowledge-base/capital-appreciation-definition/.

Capital Appreciation Definition

Capital appreciation occurs when an asset’s value or price increases or rises above the value or price at which it was acquired. Capital appreciation is a common calculation used to assess capital gains tax when an asset is sold.

A Little More on What is Capital Appreciation

The value of an asset may decline after it is acquired. If the asset declines in value, but later increases in value, capital appreciation only occurs if the value of the assets rises above the original value (or price paid) at the time of acquisition.

Capital appreciation is the primary method of achieving or earning compensation in many trades or industries – such as stock trading or real estate investment. Individuals in such industries invest in an asset, wait or take steps to make the asset rise in value, then sell the asset. The difference between the purchase price and the price at which the asset is sold is the amount of capital appreciation.

Capital Appreciation, Basis, and Taxation

Capital appreciation is subject to taxation when the asset is sold. The definition of a sale is very broad and can include instances where the property is not actually sold in the traditional sense.

When an individual acquires an asset by purchasing it, the price paid is the “basis” in the asset. If an individual receives the asset as a gift or inheritance, the basis will vary depending upon the circumstances of the transfer. Generally, the recipient of a gift takes the gifter’s basis in the asset. The basis of property inherited can be increased to the value of the asset at the time of inheritance, depending upon the relationship between the decedent and the individual inheriting the asset.

The tax rate for capital gain rates for assets held more than 12 months is 0%, 15% or 20% (long-term capital gain) depending on your taxable income and filing status. The capital gain rate for assets held less than 12 months is the individual or business’s income tax rate.

Example of Capital Appreciation of Stock

An investor invests in stock worth $10. After a year, the price of the stock increases to $15. With the price of the stock increasing to $15, the investor achieves $5 per share in capital appreciation. If he sells the shares, he will pay capital gains tax on the capital appreciation. Because he held the stock for more than 12 months, the rate of taxation with be the long-term rate (0%, 15%, or 20%), depending upon the individual’s personal income tax bracket.

Academic research on “Capital Appreciation”

  • Capital inflows and real exchange rate appreciation in Latin America: the role of external factors Calvo, G. A., Leiderman, L., & Reinhart, C. M. (1993). Capital inflows and real exchange rate appreciation in Latin America: the role of external factors. Staff Papers40(1), 108-151. The characteristics of recent capital inflows into Latin America are discussed. It is argued that these inflows are partly explained by conditions outside the region, like the recession in the United States and lower international interest rates. The importance of external factors suggests that a reversal of those conditions may lead to a future capital outflow, increasing the macroeconomic vulnerability of Latin American economies. Policy options, it is argued, are limited.
  • Non-temporal components of residential real estate appreciation Goetzmann, W. N., & Spiegel, M. (1995). Non-temporal components of residential real estate appreciation. Review of Economics and Statistics1(77), 199-206. This paper separates the components of capital appreciation returns in an asset market into fixed and stochastic portions. It proposes a control for the problem of fixed components in the capital appreciation return used in transactions-based return estimates. We find a consistent bias in the index resulting from repeat sales regressions which may be eliminated through simple methods. The sign and magnitude of the bias, as well as its systematic variation across properties, suggest that it is caused by incremental home improvements, as well as by price risk. We propose a maximum likelihood method for estimating the first and second moments of the fixed and temporal components of real estate returns that relies upon relatively small samples.
  • Self-appreciation; or, the aspirations of human capital Feher, M. (2009). Self-appreciation; or, the aspirations of human capitalPublic Culture21(1), 21-41. Human capital is to neoliberalism what Marx’s free worker was to liberal capitalism, that is, the subjective formation at once presupposed and targeted by neoliberal technologies of government. According to this thesis, the neoliberal condition involves investors in their own human capital who, as such, seek to appreciate the value of the portfolio of conducts that constitutes them and whose relationship to themselves is speculative rather than possessive—as was the case of their liberal predecessors.
  • Mortgage fund flows, capital appreciation, and real estate cycles Arsenault, M., Clayton, J., & Peng, L. (2013). Mortgage fund flows, capital appreciation, and real estate cycles. The Journal of Real Estate Finance and Economics47(2), 243-265. This paper provides strong evidence for a positive feedback loop between property prices and mortgage supply, using data from the U.S. commercial property and mortgage markets over the 1991 to 2011 period. The empirical analyses control for the endogeneity of property prices, mortgage flows, mortgage interest rates, and loan to value ratios, and provide two main findings. First, exogenous increases in mortgage supply, measured with the growth of the CMBS market, significantly reduce property cap rates. Second, volatility of past price changes and the “biggest loss” in property values in the past significantly affect mortgage supply. This positive feedback loop may be an important driving force for real estate cycles.
  • The monetary appreciation of paintings Stein, J. P. (1977). The monetary appreciation of paintings. Journal of political Economy85(5), 1021-1035. Price indices for pre-World War II paintings are developed from U.S. and U.K. auction prices, assuming that auctioned paintings are sampled from a fixed underlying stock of paintings. The simple form of the capital-asset pricing model is modified to describe durable goods with risky capital appreciation and constant service yield. Estimated parameters for U.S. paintings are β = 0.82 (SE = 0.34), R<sup>2</sup> = .24, service yield = 1.6 percent (SE = 7 percent). To individual collectors, “performance” is positive to the extent that they value the service yield above 1.6 percent. Paintings are “inefficient.” Regressions using U.K. data have no significant β coefficients.

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