A capital gain is profit earned on capital assets such as securities investments and real estate. When an investor purchases a capital asset at a certain amount and sells the asset for a higher amount, a capital gain is the result. A capital-gains tax is assessed when a capital asset is sold for profit. Many investors utilize strategic techniques for taking a capital gain or loss depending on their individual tax needs. Capital-gains taxes have both benefits and drawbacks, depending on the tax situation of the taxpayer.
One advantage of capital-gains taxes is that tax payments are deferred until the asset is sold. For example, a real-estate investor does not pay taxes on the equity gained in a property investment until the year he sells the property for a profit. Further, a securities investor does not pay capital-gains taxes on profits earned from stocks and bonds until he takes a distribution or sells the assets. Investors only pay taxes during the tax year they realize the gain. This is different than income taxes where you must pay a tax each time you receive an income payment.
According to the Internal Revenue Service, nearly everything you own for personal use or investment purposes is a capital asset. A drawback to owning capital assets is that if they are sold for profit, the IRS requires that you report gains as income. The disadvantage of this tax is that it can reduce the overall profits realized from the sale of the asset.
The amount of taxes you must pay on a capital gain depends on the length of time you owned the asset prior to selling and can either be a benefit or detriment to the taxpayer. If you owned the asset longer than 12 months and realize a profit, you have a long-term capital gain, which is taxed at a lower rate. If you own an asset less than 12 months and sell it for a profit, you have a short term capital gain, which is taxed at a higher rate. Long-term capital-gains taxes are more advantageous than short-term capital-gains taxes because its rate typically produces savings.
Taxpayers are responsible for paying federal, and in many cases, state capital-gains taxes. Property owners and investors, for example, must report capital gains from the sale of real estate on both federal and state income-tax returns in most states. The additional tax on the state level is a disadvantage for many taxpayers.