When an investor looks at their portfolio and sees that it has gone up or down in value, it can feel exciting or terrible, depending on the day.
However, the investor doesn’t actually make or lose money until they sell the assets in their portfolio. Until that time, their gains and losses are unrealized.
What are unrealized gains and losses, how can they be calculated, and why are they important for investors?
What Are Unrealized Gains and Losses?
Unrealized gains and losses are the day-to-day increases or decreases in value of an asset, such as a stock. The asset has yet to be sold for cash, at which time the gain or loss will become realized. Unrealized gains and losses are often referred to as paper profits or paper losses.
When a stock is sold that has gained or lost value, the investor makes or loses money, but they also have capital gains or losses that affect their taxes.
Generally, investors hold on to unrealized gains when they feel that the asset will continue to go up in value.
Otherwise they would choose to sell and take the profits. Investors may also choose to hold on to stocks that have gone up in value because they don’t want to pay the capital gains taxes right away, in case the tax amounts will decrease if they wait.
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. They may also decide to sell in order to offset capital gains in their tax filings. More on that below.
(Note: This article is not tax advice; consult with a tax professional if you have questions regarding your taxes.)
Calculating Unrealized Gains and Losses
In order to calculate unrealized gains and losses, subtract the value of the asset when 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.
To calculate the total amount of unrealized gains or losses, multiply the gain or loss per unit by the total amount of units owned. Meaning, if one share of stock has gone up $Z, and the investor owns Y number of shares, multiply Z x Y to get the total unrealized gains.
Here’s an example. If an investor purchases 100 shares of Company XYZ at $10 each, they start out with $1000 worth of stock. If the value of the stock increases to $12/share, they now own $1,200 worth of stock. Since the investor hasn’t yet sold the shares, their unrealized gains are $200.
Similarly, if an investor owns 100 shares of stock purchased at $10 each, and that stock decreases to $8 a share, the investor’s unrealized loss will be -$200.
Unrealized gains and losses also apply to assets other than stocks, such as precious metals, crypto trading, or real estate.
Capital Gains and Losses
Why do unrealized gains and losses matter? They can influence an investor’s decision about when to sell stock. If an investor sells a stock at a profit, they make money but also have to pay capital gains taxes on their earnings.
Conversely, if an investor sells a stock at a loss it can reduce the amount of taxes they have to pay.
Investors may choose to hold on to a stock that has risen in value in order to lower the amount of taxes they’ll pay on the gains.
If they hold a stock for more than one year, they pay long-term capital gains tax instead of the more expensive short-term capital gains tax. By investing for the long term, investors may save a significant amount on taxes over time.
Since there is no tax on unrealized gains or losses, they don’t need to be reported in tax filings.
Unrealized losses can be used to offset capital gains. If a capital loss is larger than a capital gain, an investor can offset up to $3,000 of the loss from their income taxes per year. If a loss is larger than $3,000, it can be carried over to future years.
Not all assets get taxed with capital gains. While stocks, bonds, jewelry, and one’s house all qualify, patents, copyrights, business inventory, and certain other types of assets do not.
Capital gains tax rates are based on income level, but they are different and lower than income tax rates.
The only ways to avoid paying capital gains tax are to never sell an asset, or to die. When an investor dies their assets get transferred to their heirs at the current market rate. If the heirs choose to sell an asset, they will not pay tax on capital gains that were earned between the time the asset was purchased and the time of the investor’s death.
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, just as they don’t want to see further losses to an asset that’s tanking.
Trying to time the market is extremely challenging and can result in extensive losses. 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, this means investors will pay lower capital gains taxes. If an asset has gone down in 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.
Getting Help With Financial Decisions
If you’re holding assets and deciding whether to sell or hold on to them, you may want to seek professional financial advice.
When you’re just getting started online investing, it can be overwhelming and difficult to figure out what or when to buy or sell. SoFi has a dedicated team of financial planners available to answer your personal finance questions and help you create a financial plan. Our financial planners can help you map out financial goals, but can’t give specific investment advice.
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