A business can gain or lose money in two ways. It can make a profit on its sales activities, or it might lose money by spending more than it brings in from sales. It can also gain or lose money through its investments or the sale of assets—items of value that the business owns.
Each of these types of gains or losses is taxed differently. Profits are typically taxed as ordinary income and at the "regular" business or personal tax rate. Gains or losses on investments or the sale of assets are taxed as capital gains or losses, but it can depend on the type of business.
Capital Gains and Capital Losses
Capital gains or capital losses are the gains or losses that a company or an individual experiences on the sale of a capital asset. If the selling price of an asset is higher than the owner's basis in that asset, the result is a capital gain. If the selling price is less than the basis, the result is a capital loss. The basis is generally the purchase price of the asset plus any capital improvements and costs of sale.
Capital gains and losses are also experienced when a business writes off an asset, taking it off its balance sheet. It might be the case with accounts receivable when a debt is owed to the business but is unlikely ever to be paid for one reason or another.
Almost everything a business owns and uses is a capital asset. When a capital asset is sold for a profit, a capital gain results. A capital loss results when a capital asset is sold at a loss. An example of a capital loss for a company would be a company purchasing a building for $300,000 then selling it two years later for $250,000. The $50,000 difference would be considered a long-term capital gain.
Long-Term vs. Short-Term
Capital gains and losses come in two forms: long-term and short-term. Short-term gains or losses are those on assets that are held for a year or less before being sold. Long-term capital gains and losses resulting from the sale of assets that were held or owned for more than a year before being sold.
Long-term gains are subject to tax rates of 0, 15, or 20 percent in 2018 for sole proprietors and investors. The rate depends on the individual's overall income—the more income he has, the higher the rate. Short-term gains are taxed as ordinary income according to the individual's tax bracket. C-corporations have historically paid regular corporate income tax rates on all their capital gains.
How They Affect Business Owners
Individual shareholders or business owners who sell their capital shares or owners equity in business also incur capital gains or capital losses from those sales because capital gains and losses are different from operating gains and losses.
Operating profits and losses resulting from the on-going operations of the business. Sometimes called net operating losses (NOL) for tax purposes, they result from the day-to-day operations. Capital gains and losses result from single transactions in which the business incurs a gain or a loss.