Capital gains tax

Definition

Capital gains tax is a type of tax levied on the profit or gain realised from the sale or disposition of certain types of assets, known as capital assets. 

What are capital gains tax?

The tax is applicable when the selling price of the asset exceeds its original purchase price, resulting in a capital gain. Capital assets typically include long-term investments held for a certain period, such as stocks, real estate, and other securities. 

Different tax rates apply to short-term and long-term capital gains. Short-term gains are typically taxed at the individual’s ordinary income tax rates, while long-term gains may qualify for preferential tax rates, which are generally lower than ordinary income tax rates.

Investors may consider various strategies to manage capital gains tax, such as tax-loss harvesting, where capital losses are intentionally released to offset gains, or holding investments for the long term to qualify for lower tax rates.

Capital gains tax rates and regulations can vary significantly between countries, and they may be subject to change based on legislative decisions and economic conditions.

Example of capital gains tax

Let’s consider a simple example to illustrate capital gains tax:

• Purchase of stock: Investor A purchases 100 shares of a company’s stock for £50 per share, resulting in a total investment of £5,000.
• Holding period: After holding the stock for more than one year, Investor A decides to sell the shares when the stock price has increased to £70 per share.
• Calculation of capital gain:

Selling price: 100 shares x £70 per share = £7,000

Purchase price (Basis): 100 shares x £50 per share = £5,000

Capital gain: £7,000 – £5,000 = £2,000

Since Investor A held the stock for more than one year, the capital gain is considered a long-term capital gain.

Assuming a long-term capital gains tax rate of 15%, the tax on the £2,000 gain would be 15% of £2,000, equal to £300.

After accounting for capital gains tax, the net proceeds from the sale would be:

£7,000 (selling price) – £300 (capital gains tax) = £6,700. 

Investor A realised a capital gain of £2,000 from the sale of stock and incurred a long-term capital gains tax of £300. The net proceeds after accounting for the tax are £6,700.