As every investor knows, the value of your portfolio can fluctuate constantly, with one asset going up in value or another one going down. 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’s appreciated in value, say, you’ve realized that gain. Same idea when a stock loses value: it’s considered an unrealized loss until you sell it. It’s important to keep these differences in mind as they have important tax implications.
Unrealized Gains and Losses, How Do They Work?
Unrealized gains and losses are the day-to-day increases or decreases in an asset’s value, such as a stock. Until the stock is sold for cash, the gain or loss remains unrealized, thus unrealized gains and losses are often referred to as paper profits or paper losses.
When an investor sells an asset stock 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 gains. Investors owe short-term capital gains tax on profits from the sale of a stock they’ve held for less than a year; they would owe long-term capital gains if they’ve held the stock for a year or more.
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. But investors may also choose to hold onto stocks that have gone up in value because they don’t want to pay the capital gains taxes right away.
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; capital losses can be used to offset capital gains. More on that below.
Note: This article is informative but not meant to be taken as 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.
Example of an Unrealized Gain
To calculate the total amount of unrealized gains or losses, multiply the gain or loss per unit by the total amount of units owned.
For example: If 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 hasn’t yet sold the shares, they have an unrealized gain (or paper gain) of $200.
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.
In either case, the investor hasn’t actually profited or lost any money — until they sell the asset and lock in the gain or lock in 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, that capital loss can be applied to a capital gain to reduce the amount of tax owed.
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 every year in order to adjust for inflation, so investors can learn them by searching on the Internet or talking to a professional.)
If an investor holds a stock for more than one year, they pay long-term capital gains tax instead of the higher short-term capital gains tax. Long-term capital gains tax rates are based on marital status and income level, but they are generally lower than ordinary income tax rates and fall into only three brackets: 0%, 15%, 20%.
However, a higher 28% typically applies to long-term gains involving art, antiques, stamps, wine, and precious metals.
That said, generally speaking by investing for the long term, investors may save a significant amount on taxes over time.
Thinking About Capital Losses
Capital losses can be used 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 is larger than $3,000, it can be carried over to future years.
Since there is no tax on unrealized gains or losses, these don’t need to be reported in tax filings. Meaning: Let’s say you invested in some crypto at the start of a tax year and by the end of the year it was worth $10,000 more. You would not owe any tax on that gain, until you sold the investment.
Similarly, if you invested in some crypto at the start of the year and by the end it had lost $10,000 in value; that would be a paper loss until you sold it. You wouldn’t include it on your taxes.
Not all assets fall under capital gains tax rules, so be sure to consult a professional about the most tax-efficient strategy.
Can capital gains tax be avoided?
The only ways to avoid paying capital gains tax are: 1. never sell an asset; 2. earn less than $80,000 in taxable income if you’re married, filing jointly (less than $40,000 for single filers); or 3. pass away. 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 when a stock is rising, just as they don’t want to see further losses if the stock’s price is dropping.
Trying to time the market is extremely challenging 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, this 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.
The Takeaway
An unrealized gain/loss in your portfolio may seem to have little material value at first. If you don’t make or lose money until you actually sell those securities, then unrealized gains and losses might not seem to matter — versus the more tangible impact from gains and losses you do realize.
In fact, even unrealized gains and losses can represent opportunities for investors.
You may decide to hold onto unrealized gains in order to minimize 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.
Weighing the implications of short- vs. long-term capital gains can be significant as well, because if you choose to sell an asset and thereby realize a gain, you may owe more in tax if you’ve only owned it a year or less. After a year, long-term capital gains kick in, which are typically lower than short-term.
So, if you have unrealized losses in your portfolio you might want to sell those assets and realize the loss, because capital losses can help offset capital gains. Conversely, you might not want to lock in a loss, if you believe the assets might regain their value.
So it’s not the unrealized gains or losses themselves that matter, but rather what you do with them.
Getting Help With Financial Decisions
Every investor develops their own perspective on how to handle unrealized gains and losses when they start investing on their own — and deciding how and why and why to sell securities that have gains (or losses). You can get started by opening an account with SoFi Invest® any time. Investors can choose from an array of stocks, ETFs, fractional shares, cryptocurrencies, and more.
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