Key Takeaways
- An unrealized gain is an increase in your investment’s value that you have not captured by selling the investment.
- Unrealized gains are not taxed until you sell the investment and the gain is realized.
- The tax liability on realized gains depends on your income and how long you owned the investment.
Definition and Examples of Unrealized Gains
When you invest in an asset such as a stock or ETF, you do so with the hope that it increases in value. The proper term for that increase in value is “capital gain.”
However, just because the asset has increased in value does not mean you have captured that value. If you don’t sell it and the price falls, then you won’t get to keep the gain. When that happens, the gain is said to be “unrealized.” When you sell an investment with an unrealized gain, that gain becomes realized because you receive the increased value.
For example, suppose you buy a share of stock for $45. If the price rises to $55, then you have an unrealized gain of $10.
To clearly see what an unrealized gain is, think about what you have if the stock price falls back to $45 before you sell. At that point, you simply have a share of stock that is once again worth $45. You did not capture, or “realize,” the $10 gain.
If you had sold the stock when the price reached $55, you would have realized that $10 gain—it’s yours to keep.
This may seem like a basic distinction to make, but it is a very important one because your tax bill depends on whether or not your gains are realized or unrealized. If you have a taxable gain, the timing of those gains matters as well.
How Unrealized Gains Work
The main reason you need to understand how unrealized gains work is to know how it will impact your tax bill. Unrealized gains are not generally taxed. You don’t incur a tax liability until you sell your investment and realize the gain.
However, not all realized gains are taxed at the same rate. There are two different tax structures depending on whether or not realized gains are long term or short term.
A short-term capital gain is one that is realized within a year of purchasing the investment. Short-term capital gains are taxed at your ordinary income-tax rate.
Long-term capital gains are gains that aren’t realized until at least a year has passed since you purchased the investment. The tax rate on long-term capital gains depends on your taxable income, but is a lower rate than your income-tax rate.
The tax rates on long-term capital gains for single filers are:
| Your taxable income is: | Your long-term capital gain tax rate is: |
| Less than $80,000 | 0% |
| $80,000-$441,449 | 15% |
| $441,450 and up | 20% |
Understanding the relationship between the time that passes before you realize a gain and the taxes you owe can help you with tax planning. By waiting for a year to realize any unrealized gain, you can significantly reduce the taxes you’ll owe on that gain. Your tax rate could possibly even be as low as zero.
Going back to the example, assume that you purchased the stock for $45 in July. If the price reaches $55 by December but you do not sell, then you have an unrealized gain of $10 and would owe no taxes. If you sell in December, then you have a short-term realized gain of $10. This $10 gain will be subject to your ordinary income-tax rate.
Now, assume you sold the stock at $55 two years after you bought it in July. You have a long-term realized gain of $10 and it will be subject to a tax rate of 0%, 15%, or 20% depending on your taxable income.
Unrealized Gains vs. Unrealized Losses
The opposite of an unrealized gain is an unrealized loss. If the value of your investment falls after you purchase it, you have a capital loss. The loss is unrealized until you sell the investment.
For example, if you had bought the stock in the previous example at $45, then the price fell to $35, the $10 price drop is an unrealized loss. If you sell the stock at $35, your unrealized loss becomes a realized loss of $10.
Realized capital losses can be used to offset capital gains for purposes of determining your tax liability.
What It Means for Individual Investors
If you hold investments in a tax-sheltered retirement account such as a 401(k), 403(b), or IRA, then you are shielded from capital gains taxes, so the distinction between realized and unrealized gain is less important.
If you invest in a taxable brokerage account, then taxes on your realized gains can affect your net investment returns.
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