A capital gain is a taxable event that occurs when an asset is sold for more than the purchase price.
The important distinction is the act of selling, which separates it from a “paper” gain and is the reason that the increase in value is considered taxable income.
An increase in value over the purchase price of an asset that remains unsold is considered unrealized, and is not subject to taxation.
Capital gain is an important concept for traders to understand because it plays a significant role in the overall profitability of their trading and it is a critical element in the necessary clerical paperwork that they need to file.
If the profit from each trade is subject to a 30% capital gain tax, for example, then every $100 of trading profit is actually only worth $70 to the trader in the end.
In terms of legal reporting requirements, traders need to file their gains as part of their taxes for the year, just like any other form of income.
How is Capital Gains Calculated?
Capital gain is considered a form of income and is subject to taxation.
The taxation systems in most developed countries recognize capital gain as a separate form of income with its own rates and rules, and usually faces a flat rate that is significantly lower than the average rate of taxation on standard income.
In addition, capital gain taxation systems allow for a balance of gains versus losses, so that only the total gain over the span of the full taxation period is considered taxable income.
Capital gains is calculated by taking the purchase price plus any commission or fees paid minus what you sold if for.
Short-Term vs Long-Term
In some countries, including the Unites States, there is a distinction between short term and long term capital gain, where the short term is for any asset that is bought and sold in less than one year.
Short term gain is considered a normal source of income, and is subject to the standard income taxation system and rate (which is significantly higher than long term capital gain).
Long term capital gains are assets sold for a profit that have been held for over a year. They are usually taxed at a flat rate that is much lower than short term capital gains.
Capital gains tax is just another part of trading that must be taken into consideration. A good thing to do is to talk with an accountant to make sure you are filing your trading profits correctly!