What is capital gains tax?

Capital gains tax refers specifically to the tax imposed on the profit that an investor realizes when they sell an asset for more than its purchase price. This can include various types of assets, such as stocks, real estate, and other investments. The capital gain is calculated as the difference between what the asset was sold for and what it was initially purchased for, and it is only taxed when the asset is sold — this makes it distinct from taxes on regular income or dividends.

For instance, if an individual buys shares of stock for $1,000 and later sells them for $1,500, the capital gain would be $500, and this amount would be subject to capital gains tax. Capital gains can be classified as short-term or long-term, based on how long the asset was held, which also affects the tax rate applied.

Understanding this type of tax is important for investors because it influences investment decisions and tax planning strategies. The other choices pertain to different types of taxes: taxes on dividends relate to income from investments, employment income is taxed under income tax laws, and taxes on inherited wealth apply to estates rather than gains from selling assets.