Capital profit is a type of profit that is realized when a capital asset is sold. The purpose in identifying profit that is realized due to the sale of an existing asset is often associated with tax laws that require the assessment of taxes on this type of activity be calculated differently from the realization of other types of profit. While there is some difference in application from one nation to another, the sale of any asset that is defined by law as a capital asset has the potential to generate capital profit.
In terms of accounting, most methods involve segregating capital profit from other types of profit generated by the business. This is because most national revenue agencies have specific tables and formulas for determining the amount of taxes due on different kinds of profits. By arranging the accounting books so that it is easy to extract the data relevant to the sale of the asset, the task of applying those formulas and tables to the capital profit generated is less confusing. The end result is the ability to correctly report the profit and accurately calculate the tax obligation associated with that profit.
Since the sale of capital assets often has the goal of generating cash that can be used to settle some pressing debt obligation, or to provide funding for some type of new project, there is a good chance that at least some capital profit will result. Companies typically sell off assets that are not necessary to the core operation of the business, but that can be sold at or near current market value. In the best of scenarios, that current market value is actually more than the original purchase price, and is also enough to offset any maintenance or other costs associated with owning the asset. When this is the case, the potential for achieving capital profit is very high.
As with other types of profit, the sale of a capital asset must result in the owner receiving some type of benefit above and beyond the resources used to initially acquire and maintain the asset during that time of ownership. This means that selling a capital asset does not automatically mean that capital profit is generated. The identification of a profit margin on this type of activity must be in compliance with applicable tax laws and how those laws relate to the owner’s expenses and the amount of funds received from the sale. For this reason, it is important to evaluate each individual sale of a capital asset, comparing the circumstances surrounding that sale with tax laws that apply for the time and place where the transaction occurs.