Capital Gain
What does "Capital Gain" mean in law?
A capital gain is the gain realized from the sale or exchange of a capital asset, as defined under IRC Section 1221. Capital assets include most property held by the taxpayer, with specific statutory exceptions for inventory, depreciable business property, accounts receivable, and certain creative works. The distinction between long-term capital gains (assets held for more than one year) and short-term gains (one year or less) is critical because long-term gains receive preferential tax rates. In Arkansas Best Corp. v. Commissioner (1988), the Supreme Court clarified that the definition of capital asset turns on whether the asset falls within the statutory exclusions of Section 1221, rejecting the judicially created 'business motive' test.
Definition
A capital gain is the gain realized from the sale or exchange of a capital asset, as defined under IRC Section 1221. Capital assets include most property held by the taxpayer, with specific statutory exceptions for inventory, depreciable business property, accounts receivable, and certain creative works. The distinction between long-term capital gains (assets held for more than one year) and short-term gains (one year or less) is critical because long-term gains receive preferential tax rates. In Arkansas Best Corp. v. Commissioner (1988), the Supreme Court clarified that the definition of capital asset turns on whether the asset falls within the statutory exclusions of Section 1221, rejecting the judicially created 'business motive' test.
Example
An investor who purchased stock for $10,000 and sold it 18 months later for $25,000 realizes a $15,000 long-term capital gain taxed at preferential rates rather than ordinary income rates.