A gain represents a general increase in the value of an asset or property. This occurs when the current price of something is higher than the original purchase price. Gains can be classified in various ways for accounting and tax purposes, such as gross vs. net gains or realized vs. unrealized (paper) gains. Additionally, capital gains can be categorized as short-term vs. long-term in nature.
A gain can contrast sharply with a loss, which happens when the value of property or assets declines relative to their purchase price, effectively resulting in a negative gain.
Key Takeaways
- A gain arises if the current price of something owned exceeds its original purchase price.
- Investors speak of gains whenever the market price of an asset surpasses the purchase price, but such gains may fluctuate before an asset is sold.
- Once an asset that has appreciated in value is sold, the investor has realized the gain—or, in simpler terms, made a profit.
Understanding a Gain
A gain generally refers to the positive difference between the acquisition price of an asset and its current price. A net gain factors in transaction costs and other expenses. Gains can be realized or unrealized. A realized gain is the profit received upon selling the asset, whereas an unrealized gain, or paper gain, represents an increase in value while the asset is still held by the buyer but not yet sold.
Tax considerations also differentiate whether gains are taxable or non-taxable, impacting how much of the gain actually reaches an investor’s pocket.
For investors and traders, a gain can manifest at any point during the life of an asset. For example, if an investor bought stock at $15 and it now trades at $20, they have a $5 gain. Nevertheless, a gain only truly matters when the asset is sold, converting the gains into realized profit. Throughout its lifecycle, an asset may experience many unrealized gains and losses as the market reassesses its value.
Gains and Taxes
In most jurisdictions, realized gains face capital gains tax. This tax applies not only to traditional assets but also to alternative assets such as coins, artworks, and wine collections.
How gains are taxed depends on the type of asset, the personal income tax rate, and how long the asset is held. Short-term gains (assets held for a short duration) typically face taxation as ordinary income, while long-term gains (assets held for over a year) enjoy more favorable tax rates.
A capital gain might be offset by a capital loss. For instance, if an investor realizes a $50,000 gain in stock A and a $30,000 loss in stock B, they may only need to pay tax on the net gain of $20,000 ($50,000 - $30,000). In non-taxable accounts, like an Individual Retirement Account (IRA) in the U.S. or a Retirement Savings Plan in Canada, gains remain untaxed.
For tax purposes, net realized gains rather than gross gains are relevant. In a taxable stock transaction, the taxable gain is calculated by subtracting the purchase price, after considering brokerage commissions, from the sale price.
Taxable Gain Example
Here’s an example of how a taxable gain works:
- Jennifer buys 5,000 shares at $25 = $125,000
- Jennifer sells 5,000 shares at $35 = $175,000
- Jennifer’s commission is $200
- Jennifer’s taxable gain is $49,800: ($175,000 - $125,000) - $200
Compounding Gains: The Road to Wealth
Legendary investor Warren Buffett attributes part of his wealth accumulation to compounding gains. The fundamental idea is that gains generate additional gains over time.
For example, if $10,000 is invested in a stock that gains 10% in a year, it earns $1,000. In the following year, another 10% gain brings in $1,100 ($11,000 x 10%), and after a third year of a 10% gain, the investment generates $1,210 ($12,100 x 10%). Investors who start early harness compounding gains to build substantial wealth over time.
Related Terms: short-term gain, long-term gain, capital gains tax, capital loss, profit, ordinary income.
References
- Tax Foundation. “An Overview of Capital Gains Taxes”.
- Internal Revenue Service. “Traditional IRAs”.
- FINRA. “Capital Gains Explained”.
