When you have multiple forms of income, you will likely be subject to capital gains. It is important to be clear about how and when capital gains will affect you and your investments. Essentially, capital gains are the profits one yields from any kind of personal asset. This includes personal investments from stocks or securities, or property. If you earn regular revenue from your assets then they are considered a form of income and therefore are capital gains.
However, gains are not realized and counted as part of one’s income until they are sold. Gains can come from both long-term and short-term investments. Long-term investments typically have a lower rate of taxation than short-term investments.
What assets are included in capital gains?
Only personal assets contribute to capital gains. Unless an asset is a legitimate business expense, it is considered part of one’s income and therefore must be included when filing income taxes.
It is easiest to think of capital gains in terms of the property that earns an income. So, included in such assets are holdings like land and physical properties, machinery, vehicles, furniture, jewelry, patents, trademarks, shares, securities, mutual funds. If personal property is earning an income, it has the potential to be assessed as a capital asset.
This is also true for cryptocurrency assets in certain countries. As the popularity of crypto-assets continues to grow, so do the regulations surrounding them. So, as you continue to grow your portfolio, be sure you know what you might be responsible for. Canada’s regulators, for example, consider cryptocurrencies a potential form of capital gains. Therefore, these crypto capital gains are taxable.
Let’s have a look at an example:
If Alice buys 10 stocks in KLM for $400 and then sells them for $600 she has a gain of $200 x 10, or $2000. Because her gain is what she earned from her investment, and not the total cost. That $2000 however, will be added to regular income, and that total is her total taxable income.
Exemptions
However, capital assets do not include all of the property or items you own. Instead, they refer to only those that are earning or have real potential to earn an income. So if you own a very valuable car or jewellery, these are only considered capital gains if they ever earn you an income. Vehicles rarely increase in value, so this is not typically the case. However, something like jewellery can increase in value over time, and so could be considered an asset.
Understanding Capital Gains
Here are a few important concepts to understand when we are talking about capital gains:
Capital Loss: A capital loss occurs when the asset decreases in value, and the proceeds from a sale are less than the purchase price. Basically, this is the opposite of gain, as it would count negatively towards your income.
Investment Income: The essence of capital gains is that you have an asset that earns you income. Therefore, anything that earns an income is included, which includes passive income such as property, stocks, and bonds.
Realized and Unrealized Captial: The sale of an asset demonstrates either realized or unrealized capital. It is realized if there are gains upon the sale and unrealized if the value of an asset has decreased.
Short-term capital gains: Short-term gains express the increased value of securities held for one year or less. These gains are added to any other income and are taxed accordingly, based on the total annual income.
Long-term capital gains: Long-term gains are often taxed at a lower rate than regular income. They are also usually slow growing investments. The rate of taxation of these gains will depend on several factors, including what country one lives in, and what their basic income tax bracket is.
Mutual Funds: Annual gains from mutual funds are also counted as realized capital gains. The gains from the funds are distributed to shareholders. The gains are therefore distributed and so the total value of the fund drops depending on the distribution size.
Managing Income
Remember, gains only occur when a real (tangible) asset appreciates in value. If the asset depreciates, this is counted as a loss. The idea of including losses with gains was devised to encourage long-term investment in real assets and property.
Gains and losses are in some ways a relic of an agrarian society. The machinery necessary for farming was expensive and seldom retained its value, despite its importance. By allowing depreciation on machinery this could offset the capital gain earned on the value of the farmer’s land.
Taxation
Taxation is relative to one’s income, which includes all of one’s assets. So when you hold assets, the gains made on these will contribute to your rate of taxation. A useful strategy for tax season is to sell assets in a year of lower income. This is particularly important for those who have multiple forms of active and passive income to pay attention to.
Moreover, it is important to know exactly at what point you move from one tax bracket to another. It is also important to remember income tax rates periodically.
Here is a Canadian example.
In 2024, Canada’s Income Tax Brackets are as follows:
- 15% up to $55,867 of taxable income
- 20.5% between $55,867 and $111,733
- 26% between $111,733 and $173,205
- 29% between $173,205 up to $246,752
- 33% on any taxable income exceeding $246,752
Notice how there are both large and small shifts from one income to the next. So if the sale of an asset will move your annual income from $55,000 to $60,000 you will move from the 15% to 20.5% bracket. So, if the sale can wait for a year with lower income, you may want to do just that.
The overall idea is that long-term investments provide a broader reach and more stable economy. If investors are constantly liquidating assets this contributes to volatility. While volatility has its value, governments need to incentivize large initial investments for slower longer-term gains. Make sure you have the information you need to know what is best for you in the short and long term.
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