What is the capital gains tax?

The capital gains tax is specifically levied on the profit earned from the sale of an asset when sold at a price higher than its purchase price. This form of taxation is a critical component of the tax system as it directly relates to the increase in value of an asset over the time it is held. When an individual or entity sells an investment—such as stocks, bonds, or real estate—for a gain, that profit is subject to capital gains tax.

Understanding the nature of capital gains is important in personal finance and investment planning, as the rate at which these gains are taxed can vary significantly, depending on how long the asset was held. Short-term capital gains (from assets held for less than a year) are often taxed at higher ordinary income tax rates, while long-term capital gains (from assets held for longer than a year) typically benefit from lower tax rates. This incentivizes longer investment horizons and influences decision-making among investors.

The other options relate to different aspects of finance and taxation. Thus, the correct choice highlights how the capital gains tax functions in the context of investment profits, making it a key piece of information for anyone involved in personal finance or investing.