Table of Contents
- What Are Unrealized Gains and Losses?
- How Unrealized Gains and Losses Work
- How Do You Know You Have an Unrealized Gain/Loss
- Difference Between Realized and Unrealized Gains/Losses
- Calculating Unrealized Gains and Losses
- Why Gains/Losses Are Important for Taxes
- Do Unrealized Gains/Losses Have to Be Reported?
- Knowing When to Sell
- FAQ
Unrealized gains and losses on investments are the potential losses or gains in value that the investments have accrued. However, they’re “unrealized” because an investor has not yet sold the investment. Once an investor sells or otherwise parts with the investment, they then “realize” a gain or a loss.
Unrealized gains and losses are critical for investors to understand so they know how much money they’re gaining or losing on their holdings, and to properly calculate any tax liabilities they may owe.
Key Points
• Unrealized gains and losses reflect how much an investment is up or down compared to the paid price, in theory; there are no real gains or losses until the asset is sold.
• To calculate unrealized gains and losses, subtract the asset’s value at the time it was purchased from its current market value.
• Short-term capital gains tax is taxed as regular income, while long-term capital gains tax is lower and based on income level and tax filing status.
• Investors can use capital losses to offset capital gains or taxable income to reduce their overall tax liability.
• Strategies to reduce or defer capital gains tax include tax-loss harvesting, investing in tax-advantaged accounts, and holding onto investments for longer than a year.
What Are Unrealized Gains and Losses?
Unrealized gains and losses are the changes in the value of an investment, such as stocks or bonds, that have occurred since an investor bought the asset but have yet to be realized by selling the investment. They reflect the difference between the investment’s current market value and its purchase price, and they are considered “unrealized” because they have not been turned into actual cash.
Unrealized gains and losses are often referred to as paper profits or paper losses.
It’s important to know, though, that any change in a security’s value versus its purchase price is considered an unrealized gain or loss until you sell it.
Once you sell a stock that has appreciated in value, you’ve realized that gain. The same idea applies when a stock loses value: it becomes a realized loss once you sell it. Keeping these differences in mind is essential as they have significant tax implications.
How Unrealized Gains and Losses Work
When an investor cashes out a stock or other asset that has gained or lost value, the investor makes or loses money. In the case of a gain, the investor may owe capital gains tax on the windfall. Investors owe short-term capital gains tax on profits from the sale of a stock they’ve held for one year or less; they would owe long-term capital gains if they’ve held the stock for more than a year.
Generally, investors hold on to unrealized gains when they feel the asset will continue to increase in value, known as capital appreciation. Otherwise, they would choose to sell and take the profits. But investors may also choose to hold onto stocks that have gone up in value because they want to wait to pay the capital gains taxes.
Investors may hold on to unrealized losses if they feel the asset will go back up in value. Or they may decide to sell to prevent further losses. Investors may also choose to sell to offset capital gains in their tax filings; many investors use capital losses to offset capital gains. More on that below.
How Do You Know You Have an Unrealized Gain/Loss
As noted above, an unrealized gain or loss occurs when you own an asset that has increased or decreased in value but has yet to be sold. To determine if you have an unrealized gain or loss, you can compare the current market value of an asset to the original cost or purchase price.
Difference Between Realized and Unrealized Gains/Losses
A realized gain or loss occurs when you sell an asset for more or less than its purchase price. A realized gain or loss is considered “real” because it permanently impacts your financial statement and has tax implications.
An unrealized gain or loss occurs when the value of an asset has increased or decreased, but it has not yet been sold. An unrealized gain or loss is considered “unrealized” because it only exists on paper and does not impact your taxes until you sell the asset for a profit or loss.
Calculating Unrealized Gains and Losses
In order to calculate unrealized gains and losses, subtract the asset’s value at the time it was purchased from its current market value. If the resulting amount is positive, the asset has gained in value, and there are unrealized gains. If the amount is negative, there are unrealized losses.
Example of an Unrealized Gain
To calculate the total amount of unrealized gains or losses, multiply the profit or loss per unit by the total amount of units owned.
For example, suppose an investor purchases 100 shares of Company XYZ at $10 each; they will have $1,000 worth of stock. If the value of the stock increases to $12 per share, they would now own $1,200 worth of stock. Since the investor has yet to sell the shares, they have an unrealized gain (or paper gain) of $200.
$200 unrealized gain = ($12 market price – $10 purchase price) x 100 shares owned
Example of an Unrealized Loss
Similarly, if an investor owns 100 shares of stock purchased at $10 each, and that stock decreases to $8 a share, they now own $800 worth of the stock. The investor’s unrealized loss (or paper loss) will be –$200.
-$200 unrealized loss = ($8 market price – $10 purchase price) x 100 shares owned
In either case, the investor hasn’t actually profited or lost any money; they are paper gains or losses until they sell the asset and lock in the profit or the loss.
Unrealized gains and losses also apply to assets other than stocks, such as precious metals, cryptocurrency, or real estate.
Why Gains/Losses Are Important for Taxes
Why do unrealized gains and losses matter? They can influence an investor’s decision about when to sell a stock or other asset. If an investor sells a stock at a profit, they would make money but also have to pay capital gains tax on their earnings. Conversely, if an investor sells a stock at a loss, they can use the capital loss to offset capital gains or taxable income to reduce their overall tax burden.
Fortunately, you can gauge the tax implications before selling the asset — since different tax rates and strategies may come into play.
Thinking About Capital Gains
If an investor holds an investment for up to one year before selling, that’s considered a short-term gain. A short-term capital gain is taxed as regular income, based on what tax bracket you’re in, and it’s typically higher than the long-term capital gains rate. (The Internal Revenue Service (IRS) changes these numbers annually to adjust for inflation, so investors can learn them by searching on the Internet or talking to a professional.)
Investors who hold a stock for more than one year pay long-term capital gains tax instead of the higher short-term capital gains tax. Long-term capital gains tax rates are based on income level and tax filing status, but they are generally lower than ordinary income tax rates and fall into only three brackets: 0%, 15%, and 20%.
However, a higher 28% typically applies to long-term gains involving art, antiques, stamps, wine, and precious metals.
That said, investors may save a significant amount on taxes over time by investing for the long term and benefiting from lower long-term capital gains tax rates.
Recommended: Short-Term vs Long-Term Investments
Thinking About Capital Losses
Investors can use capital losses to offset capital gains; short-term losses can offset short-term gains, and long-term losses can offset long-term gains.
If a capital loss is larger than the capital gain, an investor can deduct up to $3,000 of the remaining loss from their income taxes per year. If a loss exceeds $3,000, it can be carried over to future years in a process called tax loss carryforward.
Not all assets fall under capital gains tax rules, so be sure to consult a professional about the most tax-efficient investing strategy.
Can Capital Gains Tax Be Avoided?
Capital gains tax can potentially be reduced or deferred, but generally, it cannot be avoided entirely. Some strategies to reduce or defer capital gains tax include tax-loss harvesting, investing in tax-advantaged accounts like an IRA or 401(k), or holding onto investments for longer than a year to take advantage of long-term capital gains rates.
However, if you earn less than $94,050 in taxable income when you’re married filing jointly (or less than $47,025 for single filers or married filing jointly), you may benefit from a 0% long-term capital gain tax rate.
Do Unrealized Gains/Losses Have to Be Reported?
Unrealized gains or losses do not have to be reported for tax purposes until the asset is sold and the profit or loss is realized.
For instance, suppose you bought a stock at the start of a tax year, and by the end of the year, it was worth $10,000 more. If you continue to hold the stock, you would not owe any tax on that unrealized gain and wouldn’t include it on your taxes.
Some investment accounts and brokerage firms may provide periodic updates on unrealized gains or losses for informational purposes, but investors do not have to report this information to the tax authorities.
Knowing When to Sell
It can be difficult to figure out when to sell a stock, whether it has gone up or down in value. Investors don’t want to miss out on further gains when a stock rises, just as they don’t want to see further losses if the stock’s price drops.
Trying to time the market is challenging, however, and can result in extensive losses, never mind stress. Instead, it’s typically a better investment strategy to build up a diverse portfolio and invest for the long term — or however long it will take to reach financial goals.
In the case of unrealized gains, investing for the long term means investors will likely pay lower capital gains taxes. If an asset has lost value since it was purchased, an investor may choose to sell it to offset their gains, or they may hold on to it as part of a long-term strategy.
Rather than buying on hope and selling on fear, as many investors make the mistake of doing, more seasoned investors make purchasing and selling decisions based on their long-term goals.
Test your understanding of what you just read.
The Takeaway
An unrealized gain or loss in your portfolio may seem to have little material value at first. If you don’t make or lose money until you sell those securities, then unrealized gains and losses might not seem to matter — versus the more tangible impact you realize from gains and losses.
However, even unrealized gains and losses can represent opportunities for investors. As mentioned above, you may decide to hold onto unrealized gains to minimize capital gains taxes, for example — or because you hope an asset will continue to gain value. Or you may sell it to reap the profit, in which case you could owe short- or long-term capital gains tax.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What are unrealized gains and losses?
Unrealized gains and losses are increases or decreases in the value of an asset that has yet to be realized through a sale. They exist on paper but are not taxable until the asset is sold and the gain or loss is locked in.
How are unrealized gains and losses reported?
Unrealized gains and losses are not reported to tax authorities. You only have to report gains or losses once you sell the asset and lock in realized gains or losses. For informational purposes, some investment accounts and brokerage firms may provide periodic updates on unrealized gains and losses.
Do you have to pay taxes on unrealized gains?
You do not have to pay taxes on unrealized gains. You only have to pay taxes on gains once you sell an asset for a profit. At that point, the realized gain may be subject to capital gains taxes.
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