Capital Gains

Capital gain is the realization of an increase in a capital asset’s value when the asset is sold. Realized capital gains occur when an asset is sold, triggering a taxable event. Unrealized gains, sometimes referred to as paper gains, reflect an increase in an investment’s value before it has been sold. However, unrealized gains are not considered a capital gain or a taxable event, because the asset has not been sold.

Short-term capital gains are the sale of an asset within a year or less of ownership. Long-term capital gains are the sale of an asset after a year or more of holding the asset. This distinction and its implication in an investment strategy is important for both day traders and long-term investors. Short-term capital gains are taxed as ordinary income based on the individual’s tax filing status and adjusted gross income. Long-term capital gains are taxed at a lower rate than regular income. The long-term capital gains rate is 20% in the highest tax bracket. Most taxpayers qualify for a 15% long-term capital gains tax rate. All capital gains taxes, whether long or short term, should be reported on IRS Form 1040, Schedule D.

Mutual funds that have realized capital gains throughout the year must distribute those gains to shareholders. Many mutual funds distribute capital gains, which are proceeds from the fund’s sales of stocks and other assets, immediately before the end of the calendar year.