The difference between capital gains and other types of investment income is the source of the profit. Capital refers to the initial sum invested. A capital gain, therefore, is the profit realized when the value of the investment increases.

For example, assume you have purchased 100 shares of stock in company ABC at $10 per share. The capital expenditure, therefore, is $10 x 100, or $1,000. Now assume the value of each share increases to $20. If you sell at market value, your total income is $20 * 100, or $2,000. The capital gain on this investment is then equal to the total profit minus the initial capital, $2,000 - $1,000, or $1,000.

Investment income that is not attributable to capital gains refers to things such as earned interest or dividends. Unlike with capital gains, the amount of return for these investments is not reliant on the initial capital expenditure. In the above example, assume company ABC pays a dividend of $2 per share. If dividends are paid prior to the sale of shares, the investment income generated is $2 * 100, or $200.

Using a different example, a savings account totaling $5,000 with a 6% annual interest rate will generate investment income totaling $5,000 x 0.06, or $300, in its first year.

Another key difference between capital gains and other types of investment income is the rates at which they are taxed. Tax rates vary depending on the type of investment, the amount of profit generated and the length of time an investment is held.

  1. How are capital gains and dividends taxed differently?

    The U.S. tax code gives similar treatment to ordinary dividends and short-term capital gains, and qualified dividends and ... Read Answer >>
  2. Are capital gains taxed differently in different countries?

    Learn about capital gains taxes in the Unites States as well as those of other countries, where these tax rates vary significantly. Read Answer >>
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