Which of the following best describes capital gains tax?

Capital gains tax is fundamentally a tax applied to the profit realized from the sale of a capital asset, which has appreciated in value. The key aspect of capital gains tax is that it is calculated on the difference between the selling price of the asset and its original purchase price, also known as the basis. This means that when an individual sells an asset such as stocks, real estate, or other investments for more than they originally paid, the profit (or gain) is subject to taxation.

This understanding is essential as it recognizes that this tax only applies when the asset is sold, with the focus being on the increase in value, rather than on the length of time the asset is held, the overall income of the individual, or specific applicability solely to corporate entities. The classification of capital gains can also vary based on the holding period—usually long-term or short-term—but the defining characteristic remains that the tax applies to the gain realized from the sale of the asset. Thus, the description of it as a tax on the increase in value of a capital asset sold is accurate and encompasses both short-term and long-term capital gains taxation principles.