What is a Capital Gain?

Courtesy of Dynamic Mutual Funds, Posted 13 Jan 2015

Let's say you bought 100 shares of ABC Corp. for $10 a share. It was a brilliant move. ABC Corp. is now worth $100 a share. You decide to take some profits and sell 50 shares — half your investment. You reap $5,000, realizing a profit of $4,500. That $4,500 is a capital gain.

Let's say you also bought 100 shares of XYZ Co. for $10 a share. That didn't go quite as expected; the company's big product launch was a failure and the shares are now trading at $5 a share. You decide to sell all your shares. You realize $500 on the sale for a $500 capital loss.

What makes a capital gain or loss attractive from a tax point of view is that you bring only 50% of the gain or loss into income. So, in our ABC Corp. example, you would include only $2,250 in your income for that year. It would be taxed at your marginal tax rate.

The other advantage to capital gains or losses: is that no tax is triggered until an asset, such as a share, is sold. For example, you can continue to hold the remaining 50 shares of ABC Corp. until they reach $500 a share and you pay no taxes until you sell the shares. That allows you to defer realizing the gain or loss until a time that is tax-effective for you. You may want to wait, for example, until income is lower and your marginal tax rate comes down; or you may decide to take a loss to offset a gain.

You can realize a capital gain or loss on stocks, bonds, exchange-traded funds (ETFs) and mutual funds. If you invest in a mutual fund, you can have a capital gain when you sell the fund if the unit value of the fund has appreciated, or you may receive capital gains earned by the fund itself.

Understanding the tax consequences of your investments can make a difference to your financial well-being. Talk to your financial advisor; he or she will have more information on the taxation of investments and can suggest strategies to maximize your tax effectiveness.