Realized vs unrealized gains are fundamental concepts in investing that every investor should understand. They refer to the profits or losses on an investment, depending on whether the asset has been sold (realized) or not (unrealized).
These profits and losses are only theoretical until the investment sells. Realized vs unrealized gains (paper profits) are crucial for a successful investment career and will impact your tax planning. Psychologically, unrealized gains can create a false sense of wealth, leading investors to take on more risk than they can afford. For that reason, the important thing is to focus on realized gains.
The terms realized and unrealized can refer to stocks, bonds, collectibles, cryptocurrencies, real estate, or any other form of investment.
Realized vs Unrealized Gains Introduction
Unrealized gains, referred to as paper profits, exist on paper but have not been realized through a transaction.
They represent the potential profits of an investment. It is the increase in the market value of a stock compared to its original purchase price.
For example, if you bought a stock for $200 per share and its current market value is $250, you have an unrealized gain of $50 per share. There is no profit yet, and a loss can still occur.
Realized Gains
The investment sells for a price higher than the original purchase price. There is a profit. If you sell the stock at $250 per share, you have realized a gain of $50 per share.
Realized vs Unrealized Gains Importance
It’s important to understand the difference between realized vs unrealized gains.
Tax planning
Realized gains are taxable, while unrealized gains are not.
Portfolio management
Unrealized gains represent potential profits, but they can also incur losses.
Risk management
Unrealized gains can lead you to take on more risk than you can afford.
Unrealized Losses
We can’t discuss realized vs unrealized gains without talking about losses. Unrealized losses are a decrease in the value of an investment that hasn’t been sold or closed yet. It represents a paper loss that exists only on paper and not through a sale transaction.
Unrealized losses can be temporary because the value can still rise and become an unrealized gain. However, it would be best if you didn’t hold on to losing trades for too long unless you can afford it or there is a reasonable chance the momentum will swing.
Realized Losses
Realized losses are an investor’s worst enemy. Once any stock sells for a loss, that chapter is over, and a new one can begin.
Unfortunately, realized losses can harm our trading psychology. They can create a domino effect, and you can make trades to win what you lost unsuccessfully. Fortunately, realized losses can be beneficial when it comes to tax reporting.
Realized vs Unrealized Gains Tax Implications
Gains and losses have a huge impact on your tax implications. Their timing can be crucial. The following section is for the US only. The rules will differ based on your country and your investment accounts with realized vs unrealized gains.
Unrealized gains
Unrealized gains are not taxable because the investment hasn’t been sold yet. In this case, there aren’t any nuances.
Realized gains
Realized capital gains in the US are taxed based on the asset’s holding period and the taxpayer’s income level. Gains from assets held for one year or less before being sold are considered short-term capital gains. They are taxed at the same rate as ordinary income from sources like wages or interest. The tax rate depends on the taxpayer’s taxable income and filing status.
Conversely, gains from assets held for more than one year before being sold are considered long-term capital gains. They receive tax treatment with lower rates than ordinary income. In 2024, the long-term capital gains rates are:
- 0% – for incomes up to $47,025 (single) or $94,050 (married filing jointly).
- 15% – for incomes $47,026 – $518,900 (single) or $94,051 – $583,750 (married filing jointly).
- 20% – for incomes over $518,900 (single) or $583,750 (married filing jointly).
Note: Qualified dividends get taxed at the preferential long-term capital gains rates.
Realized vs Unrealized Gains Special Tax Rules
Finally, special tax rules apply to certain assets with realized vs unrealized gains.
- Collectibles (art, antiques, coins, stamps, etc.) – Taxed at a 28% rate for long-term capital gains instead of the regular 20% rate.
- Real estate – Taxed at a maximum rate of 25% for depreciation recaptures. There are special rules for flipped properties held for less than a year, where gains could be treated as ordinary income.
- Business assets – Inventory, depreciable property, copyrights, patents, and other business assets are not eligible for the preferential long-term capital gains rates. They get taxed as ordinary income, although there can be some exceptions. Some patents or copyrights can be subject to capital gains tax based on their content.
- Non-qualifying securities – Shares of certain non-public corporations, bonds/obligations, etc., may be fully taxable as ordinary income. Most stocks and investment securities are taxed as capital gains when sold. However, gains may be taxed as ordinary income in special cases, such as when securities are held by professional traders or treated as business inventory.
Reinvesting Capital Gains
Reinvesting capital gains or dividends in a taxable account prevents you from paying taxes on them in the US. However, the only way to defer taxes on reinvested capital gains and dividends is by holding the investments in tax-advantaged retirement accounts like IRAs and 401(k)s. Within these accounts, you can reinvest without tax until funds are withdrawn during your retirement.
Unrealized losses
One of your holdings is significantly in the red, and it’s toward the end of the year. What do you do? People can sell their investments for tax purposes to realize capital losses. It can offset capital gains and reduce your overall tax liability. This strategy is known as tax-loss harvesting.
Realized losses
We conclude with realized losses. How can they benefit you when it comes time to file your taxes? If capital losses exceed gains in a year, up to $3000 of net capital losses can be deducted against ordinary income. Remaining capital losses can be carried forward indefinitely to offset future capital gains. Let’s look at three examples to clear things up:
- If you have $9000 in capital gains and $4000 in losses, you can net them out and only pay taxes on the $5000 net capital gain.
- What if you had $8000 in losses but only $5000 in gains? You could deduct the full $3000 net loss against your ordinary income.
- If you had $9000 in losses and $4000 in gains, you could deduct $3000 against income that year and carry forward the remaining $2000 net loss to future years.
Note: This does not apply to realized losses in IRAs or 401(k)s.
Final Thoughts: Realized vs Unrealized Gains
Understanding the difference between realized and unrealized gains is an important part of becoming a smarter investor. Unrealized gains represent “paper profits” that can rise or fall with the market, while realized gains occur only after you sell an asset and lock in your profit or loss.
The key takeaway is simple: unrealized gains aren’t taxed, but realized gains often are. If you know when your gains become taxable, it can help you plan your trades better. As a result, you’re able to manage risk and avoid surprises during tax season.
Whether you’re into long-term investing or are trading actively, keeping track of realized versus unrealized gains is essential for making informed financial decisions.
Frequently Asked Questions
Unrealized gains or losses are only theoretical and exist only on paper. Once they sell, they become realized.
No, you do not pay taxes on unrealized gains. You do not have to report them on your tax returns.
Realized gains are taxed like income when they are held for less than one year. After one year, they are considered long-term capital gains and receive preferential tax treatment with lower rates than ordinary income (0%, 15%, or 20%, depending on your income level).
Some assets, such as collectibles, real estate, business assets, and non-qualifying securities, will be taxed at different rates.
