What is capital gains tax?

Capital gains tax refers specifically to the tax that is imposed on the profit realized from the sale of an asset, such as stocks, bonds, or real estate, when the sale price exceeds the original purchase price. This type of tax is significant because it applies only when the asset is sold, as opposed to when it is held. Capital gains can be classified as short-term or long-term, depending on how long the asset was held before selling—short-term gains typically being taxed at the individual's ordinary income tax rate and long-term gains often at a reduced tax rate.

The focus on profits from asset sales distinguishes capital gains tax from other types of taxes, such as income tax from payroll, dividends tax, or tax on business operations, each of which pertains to different financial scenarios. Understanding capital gains tax is crucial for investors and individuals handling asset transactions, as it impacts the overall return on investments and financial planning strategies.