What is capital gains tax?

Capital gains tax is specifically a tax imposed on the profit made when an asset is sold for more than its purchase price. This profit is considered a capital gain. In real estate, if a property owner sells their property for a higher price than what they originally paid, they realize a capital gain and thus become liable for capital gains tax on that profit. This tax applies to various types of assets, including stocks and bonds, but in real estate, it's a critical concept for owners and investors to understand, as it directly impacts the net proceeds from a sale.

The other options describe different aspects of taxation related to real estate but do not accurately define capital gains tax. For instance, a tax on the income generated from rental properties pertains to ordinary income tax rather than capital gains. A tax levied on property ownership typically refers to property tax, which is assessed based on the value of the property itself. A penalty for underreporting property value does not relate to the concept of capital gains; instead, it relates to tax compliance and reporting accuracy. Thus, the correct understanding of capital gains tax is crucial for anyone involved in real estate transactions to manage their tax liabilities effectively.