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What Are Unrealized Gains and Losses?
Gains and losses can be either realized or unrealized. Unrealized gains and losses reflect changes in the value of an investment in your portfolio before it is sold. Investors realize a gain or a loss only when they sell an asset (unless the purchase and sale prices are the same).
A gain occurs when the current price of an asset rises above the amount that an investor paid for it. A loss means the price has dropped since the investment was made.
This article examines the differences between realized and unrealized gains and losses as well as their respective tax consequences.
Key Takeaways
- An unrealized gain is an increase in the value of an asset or investment that an investor holds, such as an open stock position.
- An unrealized loss is a decrease in the value of an ongoing investment.
- A gain or loss on an investment is realized when the investment is sold.
- Capital gains are taxed and capital losses may be deducted only after they’re realized.
- Unrealized gains and losses remain subject to change, but they can help you minimize the taxes you owe.
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Dealing With Unrealized Gains
The value of a financial asset traded in financial markets can change any time those markets are open for trading, even if an investor does nothing.
For example, if you bought stock in Acme, Inc. at $30 per share and the most recent quoted price is $42, you’d be sitting on an unrealized gain of $12 per share. You could realize that gain if you sold Acme at $42 per share. Otherwise, your bottom line (and your unrealized gain or loss) will continue to fluctuate with the market share price.
Fast Fact
Unrealized gains and losses are also called paper profits or losses. That’s because the gain or loss only exists on paper while the asset is in the investor’s possession, generally on the investor’s ledger.
Handling Unrealized Losses
An unrealized loss is the opposite of an unrealized gain. It occurs when the price of a current investment declines below its purchase price. The loss remains unrealized until the investment is sold, at which point it becomes realized.
A realized loss is the opposite of a realized gain. You incur a realized loss when you sell an asset for less than its purchase price. So if you purchase a share of stock at $50 but end up selling it for $35, you have realized a loss of $15.
Advisor Insight
Theodore E. Saade, CFP®, AIF®, CMFC
Signature Estate & Investment Advisors LLC, Los Angeles, CA
Unrealized gains and losses (aka “paper” gains/losses) are the amount you are either up or down on the securities you’ve purchased but not yet sold. Generally, unrealized gains/losses do not affect you until you actually sell the security and thus “realize” the gain/loss. You will then be subject to taxation, assuming the assets were not in a tax-deferred account.
If, say, you bought 100 shares of stock “XYZ” for $20 per share and they rose to $40 per share, you’d have an unrealized gain of $2,000. If you were to sell this position, you’d have a realized gain of $2,000, and owe taxes on it.
Tax-loss harvesting, short/long term capital gain consideration, and your income tax bracket, are important factors to consider when deciding on what steps to take with positions at a gain or loss.
Assessing Tax Consequences
Unrealized gains and losses have no tax consequences. Until an investment is sold, its performance is not reported to the Internal Revenue Service (IRS) and has no bearing on the taxes an investor may owe.
At the same time, calculating your unrealized gains (or losses) in a taxable investment account is essential for figuring out the tax consequences of a sale.
Because realized capital losses legally can offset taxable capital gains and, to a limited extent, ordinary taxable income, many investors attempt to time asset sales so that they minimize their tax bill.
Important
You must report a capital gain or loss on your tax return for the year in which the asset was sold.
How Capital Gains Are Taxed
Capital gains are categorized as short- or long-term. Short-term capital gains are realized on assets that are held for a year or less. They are taxed as ordinary income.
Long-term capital gains are realized on assets that are held for more than a year. These capital gains are taxed at a rate of 0%, 15%, or 20%. The rate applied depends on your filing status and your taxable income for the year. The IRS sets and adjusts the income ranges for inflation annually.
Tip
You can claim a capital loss for any securities you own and relinquish, but there are restrictions on deducting uncollectible bad debts.
Example of Unrealized Gains and Losses
Let’s say you buy shares in TSJ Sports Conglomerate at $10 per share. But the price plummets to $3 per share shortly thereafter. You decide not to sell it at this point, which means you have an unrealized loss of $7 per share ($10 – $3).
Now, let’s say the company’s fortunes shift and the share price soars to $18. Since you still own the shares, you now have an unrealized gain of $8 per share ($18 – $10).
How Are Unrealized Gains and Losses Accounted for?
Unlike realized capital gains and losses, unrealized gains and losses are not reported to the IRS. But investors will usually see them when they check their brokerage accounts online or review their statements. And companies often record them on their balance sheets to indicate the changes in values of any assets (or debts) that haven’t been realized or settled.
Are Unrealized Gains Taxed?
Unrealized gains are not taxed by the IRS. This means you don’t have to report them on your annual tax return. Capital gains are only taxed if they are realized. These gains must be reported in the year they occur.
Can I Invest My Capital Gains to Avoid Paying Taxes?
There are certain investments that reinvest capital gains, thereby allowing you to avoid paying taxes. For instance, capital gains that are realized by mutual funds or stocks held in a retirement account may be reinvested automatically on a tax-deferred basis. This means you don’t have to report them and, as such, don’t immediately increase your tax burden.
The Bottom Line
You can experience an unrealized gain or loss in the value of an investment in your portfolio as its market price moves above or below the price at which you purchased it. If you decide to sell your investment, you then will have either a realized capital gain or loss.
Although you don’t make or lose money when gains are unrealized, being aware of them can help you make important decisions about your investment portfolio. So it’s important to keep track of how your assets are performing.
