A capital gain is basically a realized profit. It occurs when you've invested capital in something, and then sold it at a profit. (If you sell it at a loss, you have a capital loss.)

The term capital gain is mostly used for tax purposes. In Canada at least, capital gains are taxed differently (and more favourably - the current rate, after a recently (October 2000) announced reduction, is that only 50% of the amount of capital gains are taxable) than other income. This is an effort by the government to encourage investment in the canadian equity markets, which generally has a stimulative effect on the economy. Ahhh, progress marches on.

To clarify, consider an example:

  • You own, say, an ice cream business.
  • You buy a premises for $100,000.
  • Two years later, you sell the same premises for $150,000 -- it's not that you've done anything to improve it at all, it's just it's the way real estate works.

Then you have made capital gains of $50,000. The thing that distinguishes from normal profits is that it's not the result of normal profit-making activities -- in this case, the increase in the value of the premises has nothing to do with selling ice cream. It's just a bonus.

Capital gains is also applied to the business itself, on what is called goodwill. The goodwill of a company is the difference between what the company's property is worth and how much it is sold for. For example, if a company owns $100,000 worth of stuff and owes nobody anything, but it gets sold for $200,000, then there is a goodwill of $100,000. Increases in goodwill are considered capital gains. This is also taxable, even though it could be argued that this was perhaps a direct result of the company's activities.

Some countries also have inflation-adjusted capital gains, in other words, you only pay capital gains on the sum over and above the increase in things' values due to inflation.

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