Gains or losses are said to be “realized” when a stock (or other investment) that you own is sold. Unrealized gains and losses are also commonly known as “paper” gains or losses.
An unrealized loss occurs when a stock declines after an investor buys it but has yet to sell it. If a large loss is not realized, the investor probably expects the stock’s fortunes to change and the stock’s value to rise beyond the price at which it was purchased. If the stock rises above the original purchase price, then the investor would have an unrealized profit for as long as they hold the stock.
What are unrealized gains and losses?
- An unrealized gain is an increase in the value of an asset or investment that an investor has but has not yet sold for cash, such as an open stock position.
- An unrealized loss is a decrease in the value of an asset or investment that an investor has rather than selling it and realizing the loss.
- Unrealized gains or losses are also known as “paper” gains and losses.
- A gain or loss is realized when the investment is actually sold.
- Capital gains are taxed only when realized; capital losses can only be deducted when they are realized.
Example of unrealized gains and losses
Let’s say you buy shares in TSJ Sports Conglomerate at $ 10 per share and then soon after, the share price plummets to $ 3 per share. But you don’t sell it. At this point, you have an unrealized loss on this stock of $ 7 per share, because the value of your shares is $ 7 less than when you first entered the position.
Now, let’s say the company’s fortunes change and the stock price shoots up to $ 18. Since you have not yet sold the shares, you will now have an unrealized profit of $ 8 per share ($ 8 above where you first bought).
Calling unrealized gains or losses as gains or losses “on paper” implies that the gain / loss is only real “on paper”. This is especially important from a tax perspective since, in general, capital gains are taxed only when they are realized, and you can only deduct capital losses on your tax return after they are also realized.
To achieve the greatest tax benefit, you’ll want to be strategic about how you deduct your capital losses. If you have capital gains and losses in the same year, you can use your capital losses to reduce your tax burden by offsetting your capital gains. A capital loss can also be used to reduce the tax burden of future capital gains. Even if you have no capital gains, you can use a capital loss to offset ordinary income up to the allowable amount.
You may be able to take a total loss of capital in a share you own that has been reduced to zero because the company went bankrupt or went bankrupt. A tax professional can advise you on the forms to complete and the best strategy for your situation.
Of course, while this is how it works from a tax perspective, remember that a loss is a loss, whether it was realized or not. For some investors, learning how to take your profits and cut your losses is the key to long-term investment success.
Theodore E. Saade, CFP®, AIF®, CMFC
Signature Estate & Investment Advisors LLC, Los Angeles, CA
Unrealized gains and losses (also known as “paper” gains / losses) are the amount that is above or below the securities that you have purchased but have not yet sold. Generally, you are not affected by unrealized gains / losses until you actually sell the security and therefore “realize” the gain / loss. It will then be taxable, assuming the assets were not in a tax-deferred account. If, for example, you bought 100 “XYZ” shares for $ 20 per share and they went up to $ 40 per share, you would have an unrealized profit of $ 2,000. If you sold this position, you would have a realized profit of $ 2,000 and would owe taxes on it.
Collecting tax losses, considering short / long-term capital gain, and your income tax level are important factors to consider when deciding what steps to take with profit or loss positions.