Difference Between Capital Gains and Income

Capital Gains vs Income
 

The purpose of making an investment is to gain some sort of financial benefit at the time of maturity. Profits can be in the form of income or capital gains, which will depend on how the asset is characterized, the time period held, and the purpose for which the asset was utilized. Identifying between income and capital gains can be tricky especially in relation to sale of assets. The following article clearly defines income and capital gains by providing comprehensive examples, and explains the differences and similarities between the two.

Capital Gains

Capital gains are defined as the gains that arise from the sale of a capital asset that is used for business purposes, or is held for a period of more than one year. In simpler terms, capital gains arise when an investor/individual makes a profit from the appreciation in the value of an asset. Capital gains are profits associated to assets such as stocks, land, building, investment securities, etc. Capital gains are obtained by individuals when they are able to sell their assets at a price higher than the price at which they purchased the asset. The difference between the purchase price and higher sale price is called a capital gain.

Capital gains are taxable, and the rate of taxation applied for capital gains are usually higher. However, paying capital gains tax can be avoided by investing the proceeds from the sale of the asset in a similar asset within 180 days of the sale.

Income

Income, on the other hand, refers to any funds inflow that arises from the sale of an asset which is not considered to be a capital asset. For individuals, income usually refers to things like salaries, wages, commissions, year-end bonuses, etc. For a company, the income would be the net income received once all expenses have been deducted. Income is also taxed, but not at a lower rate so as to encourage more investment.

Capital Gains vs Income

The distinction between capital gain and income can become quite tricky when the sale of an asset is involved. However, one easy method to distinguish between the two is to look at the period for which the asset was held. If the asset was held for over a year, the proceeds of sale, for certain, would be considered to be capital gain. However, if the asset was held for a shorter term, the sale proceeds would be considered to be income.

For example, the sale of machinery used for 5 years in the manufacturing plant would be considered a capital gain. However, the sale of stock which is held for a much shorter term is considered income. Another major distinction between the two is that tax for capital gains is higher than the tax rate for income.

Summary:

• Profits can be in the form of income or capital gains; which will depend on how the asset is characterized, the time period held, and the purpose for which the asset was utilized.

• Capital gains are defined as the gains that arise from the sale of a capital asset that is used for business purposes, or is held for a period of more than one year.

• Income, on the other hand, refers to any funds inflow that arises from the sale of an asset which is not considered to be a capital asset.