What Are Capital Gains? (2024)

Definition and Examples of Capital Gains

A capital gain is the increase in an asset’s value between the time you buy it and the time you sell it. You've experienced a capital gain if you sell a capital asset for more than you paid for it. You've had a capital loss when you sell something for less than you paid for it.

The IRS uses an adjusted basis to determine if there’s been a capital gain. In most cases, the adjusted basis of an asset is simply the amount it costs you to buy it. The adjusted basis—and therefore the capital gain—is determined by the item’s fair market value when you receive it if you're given an item as a gift or you paid less than its full value.

How Capital Gains Works

You'll experience a capital gain any time you sell a capital asset for more than you initially bought it. Just about anything of value could result in a capital gain, but it most often applies to assets such as homes, investments properties, stocks, bonds, and other securities.

Imagine you bought 10 shares of stock in your favorite company, with each share valued at $100. One year later, the stock’s price has increased to $120, and you decide to sell. You bought the stock for a total of $1,000 ($100 x 10 shares), and you were able to sell it for $1,200 ($120 x 10 shares). You’ve therefore experienced a capital gain of $200, which will be subject to capital gains taxes.

It’s also possible to experience a capital loss when you sell an asset for less than you paid for it and that loss exceeds any capital gains you had for the year. The IRS allows you to deduct up to a certain amount to reduce your taxable income for the year when you have a capital loss.

Let’s say that you bought those same 10 shares of stock at $100 per share, but you were only able to sell them for $90 per share instead of for a profit. The shares were worth a combined $1,000 when you bought them and just $900 when you sold them. You experienced a capital loss of $100.

Capital Gains and Mutual Funds

Capital gains work a bit differently when it comes to mutual funds. Unlike other assets, you don’t have capital gains only when you sell your shares.

Mutual fund managers buy and sell shares and pass earnings along to the fund shareholders in the form of distributions throughout the year. They’re still considered capital gains and will be subject to capital gains taxes even if you reinvest these distributions. Distributions will likely be considered short-term capital gains because these transactions occur throughout each year.

Types of Capital Gains

The IRS categorizes capital gains into two categories: short-term and long-term.