When it comes to investing, the whole point of the game is to make money. You want to eventually be able to sell an asset for more than you paid for it or hold on to it as its value increases over time. That way, you have monetary gains in the asset that you can leverage as either cash or equity.
Watching the value of your investments increase is a great feeling. However, when it comes time to sell, the amount of increase can have big implications for your taxes. Oftentimes, the difference between what you paid for your investment and what you're now selling it for is recognized taxable gain, meaning that you will have to give the government a slice of any profits that you reap. Still, how much tax you'll pay depends on the specifics of your situation and how long you have held your asset.
What is Recognized Gain?
Recognized gain is when you are able to sell an investment for more than what you paid for it. Although you might have known that your investment had increased in value ("gained") before it was sold, that gain was largely hypothetical until an actual sale occurred. Once the sale happens, the increase is recognized: thus, the term "recognized gain."
How to Calculate Recognized Gain
To calculate recognized gain, you simply deduct the price you paid for the asset from the price for which you sold it. For example, if you just sold your house for $450,000 after paying $250,000 for it when you bought it, your recognized gain is $200,000. Recognized gain doesn't just apply to real estate; it applies to any investment.
What is Capital Gain?
Capital gain is when an investment or property is sold for more than what was paid. If you have a recognized gain on your investment, you've had a capital gain as well. In lots of situations, although not all, this triggers capital gains tax. In most cases you will pay tax on the amount of the recognized gain. However, in some situations, the IRS only taxes the realized gain, which is the recognized gain minus any expenses or fees that were paid in order to sell the asset.
The tax rate for recognized gain and capital gain varies depending on your tax bracket and how long you have held the asset. If you bought the asset less than a year ago, you'll pay more in taxes on recognized taxable gain. If you've held the asset long term (defined by the IRS as more than a year), you will pay less tax, although the capital gains tax can still be up to 20 percent for some taxpayers.