Capital Gains explained with examples!

Capital gains are the profits derived from selling capital assets like stocks, bonds, real estate, or other investments. They're computed by subtracting the initial purchase price of the asset from its selling price. Capital gains can be categorized into two main types based on the holding period of the asset:

1. Short-term capital gains: These are gains earned from the sale of assets held for one year or less. Short-term capital gains are typically taxed at ordinary income tax rates, which are usually higher than the tax rates for long-term capital gains.
   

2. Long-term capital gains: These are gains earned from the sale of assets held for more than one year. Long-term capital gains are usually taxed at preferential rates, which are typically lower than ordinary income tax rates. The rationale behind this preferential treatment is to encourage long-term investment and economic growth.

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Short Term Capital Gain

Suppose you purchased 100 shares of a company's stock on January 1st, 2023, for $50 per share, totaling $5,000. You then sell all 100 shares on September 1st, 2023, for $70 per share.

1. Determine the total sale price: 100 shares * $70 per share = $7,000.

2. Determine the total purchase price: 100 shares * $50 per share = $5,000.

3. Calculate the capital gains: $7,000 (sale price) - $5,000 (purchase price) = $2,000.

Since you held the stocks for less than a year (from January 1st to September 1st), the capital gains are considered short-term.

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Long Term Capital Gain

Now, let's consider a scenario where you purchased another 100 shares of the same company's stock on January 1st, 2022, for $40 per share, totaling $4,000. You hold onto these shares until January 1st, 2024, and then sell all 100 shares for $80 per share.

1. Determine the total sale price: 100 shares * $80 per share = $8,000.

2. Determine the total purchase price: 100 shares * $40 per share = $4,000.

3. Calculate the capital gains: $8,000 (sale price) - $4,000 (purchase price) = $4,000.

Since you held the stocks for more than a year (from January 1st, 2022, to January 1st, 2024), the capital gains are considered long-term.

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Taxation

In many tax jurisdictions, short-term capital gains are typically taxed at ordinary income tax rates, while long-term capital gains often enjoy preferential tax rates, which are usually lower than ordinary income tax rates. The exact tax rates and rules may vary depending on your country's tax laws, so it's essential to consult a tax professional for personalized advice.