Financial Glossary
Capital Gains
Capital gains are the profits realized when a capital asset -- such as real estate, stock, a business interest, or cryptocurrency -- is sold or exchanged for more than its adjusted cost basis. The gain is classified as short-term if the asset was held for one year or less, or long-term if held longer; these categories are taxed at different rates under U.S. federal law. The adjusted basis accounts for the original purchase price plus improvements and minus accumulated depreciation. Unrealized gains on assets still held do not trigger tax liability; the gain becomes taxable in the year the disposition occurs.
Problem & Application
An investor purchases an RV park for $800,000 and operates it for seven years. Over that period, the property's accumulated depreciation reduces the adjusted basis to $620,000. The park sells for $1.3 million. Total gain is $680,000, but it is split into two components: $180,000 of depreciation recapture (taxed at a higher ordinary-income-adjacent rate) and $500,000 of long-term capital gain (taxed at a lower preferential rate). Failing to anticipate the depreciation recapture component -- sometimes called Section 1250 unrecaptured gain -- leads sellers to underestimate their tax bill by tens of thousands of dollars. Installment sales, 1031 exchanges, and opportunity zone investments are mechanisms that can defer or reduce the resulting liability, but each requires advance planning; they cannot be retroactively applied after closing.
In Short
Capital gains are a key aspect of wealth creation, requiring strategic planning to balance growth and tax efficiency. Investors benefit from aligning capital gains strategies with long-term financial goals.