Have you ever wondered what the difference is between investment income and capital gain? Well look no further, we’re here to clarify the difference in a simple way! Lets start off with capital gains.
A capital gain occurs when a person realizes a profit from the investment of capital. For example, Person A acquires a parcel of land in year 1 which costs $100,000 (this is the investment of capital or also referred to as the capital expenditure). The intention of the purchase is to hold the land for 1 year and hope the property appreciates in value. Now, it’s year 3 and the value of the land has increased by a whopping 100% and is worth $200,000. Person A now shops around the listing and finds a reputable realtor which agrees to list the land and it sells for an astronomical price of $250,000 (because Person A resides in Vancouver, duh)! In this example, the capital investment is $100,000. Assuming a selling price of $250,000, the capital gain realized for Person A is $150,000 ($250,000-$100,000). Person A will pay tax on 50% of the capital gain which will be $75,000.
On the other hand, the most common types of investment incomes are interests and dividends. The main characteristic of investment income is that it does not rely on a capital expenditure as mentioned above. For example, Person B deposits $50,000 is a savings account at the local credit union which provides 3% annual interest in return. In the first year Person B will generate $1,500 of investment income. Simple, right?
Now, I know there are factors that could come into play that need to be addressed situation by situation. I have merely skimmed the surface of these topics but I hope this article clears up the distinction between what is classified as a capital gain and what is investment income. For instance, one key difference that was not mentioned is the rates of which each type of income is taxed. For more information, please reach out to us at [email protected] to discuss further! We’d be more than happy to provide guidance on a case by case basis.