What are capital gains?

Capital gains refer specifically to the profits that an individual or an entity realizes from the sale of an asset that has increased in value compared to its purchase price. These assets typically do not form part of the regular operational activities of a business.

When you sell a long-term asset such as stocks, bonds, real estate, or collectibles for more than you paid for them, the difference is classified as a capital gain. This concept distinguishes capital gains from other types of income, such as ordinary business income derived from the regular functions and operations of a company.

Understanding that capital gains apply to assets outside of routine business operations helps clarify the distinction between different types of income. For instance, the profits derived from selling inventory as part of a business's core activities would be categorized as regular business income, rather than capital gains.

This is essential for tax implications too, as capital gains can be taxed differently than regular income, often at a preferential rate. Thus, identifying that capital gains arise from selling non-operational assets is a key point in understanding financial concepts related to investments and their real-world implications.