Difference between long term and short term capital gain


Learning objective:
What is the Difference between long term and short term capital gain?

Long term capital gain

Capital gain arises when a capital asset is sold at more than its cost. It is calculated as sales proceeds less cost of the asset. Long term capital gain is the gain arising on sale of long term capital assets. Long term capital assets are those that are held for long period of time before sale. Long period of time is any time period of more than one year. Assets like land, buildings, plant and machinery and motor vehicles are normally held for more than one year and are classified as long term capital assets and therefore give rise to long term capital gain.

Short term capital gain

Short term capital gain is the capital gain arising on short term capital assets. Short term capital assets are those which are held for short period of time and any period of less than one year is considered as short time period. Some capital assets are bought in view of resale when its market value will increase and are sold within one year after increase in its market value. Such assets give rise to short term capital gain. For example if a vehicle purchased for $2,000 and after six months its value increases to $3,500 and is sold, it will give rise to short term capital gain of $500 because vehicle was held for less than one year.

Differences between long term and short term capital gains

There are some differences between long term and short term capital gain which are explained below:

1. Holding period of the asset

Major difference between long term and short term capital is the holding period of the capital asset giving rise to capital gain before disposal. If asset is held for long period of time which is more than one year, it will give rise to capital gain. And if capital asset is held for short period of time which is less than one year then it will give rise to short term capital gain.

2. Purpose of holding the asset

If the purpose of holding the capital assets is to use in business activities then it will normally be held for its full useful life which is more than one year and it will give rise to long term capital gain. If the purpose of holding the assets is to relies the increase in fair value of the asset then it will be held for short time period and will be sold when its fair value has increased and this will give rise to short term capital gain.

3. Manner in which related benefit will be realized

If a business indents to realize the related benefit from an asset by using it and generating operating cash flows then normally it will be held till maturity and will give rise long term capital gain when sold. If business wants to realize the related benefit by selling the asset when its value has increased then it will be sold after short time when its value has increased and will give rise to short term capital gain.

4. Measurement of the asset

If capital asset is a financial asset, it can be measured either at fair value or at amortized cost in financial statements. If asset is measured at amortized cost it will be held till maturity of the asset and will give rise to long term capital gain when sold. If financial asset is measured at fair value then it will normally be sold within short period of time and will give rise to short term capital gain.

Conclusion

Major difference between long term and short term capital gain is the holding period of the capital asset on which gain arises. If asset is sold after holding for more than one year, it will result in long term capital gain and if capital asset is sold after holding for less than one year, it will result in short term capital gain.

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