The term unrealized gain refers to an increase in the value of an asset, such as a stock position or a commodity like gold, that has yet to be sold for cash. As such, an unrealized gain is one that takes place on paper, as it has yet to be realized. An unrealized gain becomes realized once the position is sold for a profit. It is possible for an unrealized gain to be erased if the asset’s value drops below the price at which it was bought.
Key Takeaways
- An unrealized gain is a theoretical profit that exists on paper, resulting from an investment that has not yet been sold for cash.
- Unrealized gains are recorded on financial statements differently, depending on the type of security: held-for-trading, held-to-maturity, or available-for-sale.
- Gains do not affect taxes until the investment is sold and the gain is realized.
- If an investment is held for longer than a year, the profit is taxed at the capital gains tax rate.
- An unrealized loss is the opposite of an unrealized gain, where an investment has decreased in value but has not yet been sold.
How an Unrealized Gain Works
An unrealized gain occurs when the current price of a security is higher than the price the investor initially paid for the security, including any fees associated with the purchase. Many investors calculate the current value of their investment portfolios based on unrealized values. In general, capital gains are taxed only when they are sold and become realized.
Investors may choose to sit on unrealized gains for tax benefits. Most assets held for more than one year are taxed at the long-term capital gains tax rate, which is either 0%, 15%, or 20% depending on one’s income. Assets held for one year or less are taxed as ordinary income, with rates ranging from 10% to 37%.
In 2022, a single filer making $41,675 will pay 0% on realized long-term capital gains, and an individual making $459,750 will pay only 15%. That single filer pays 0% if they make $44,625 while the 15% rate is applied to a single filer earning $492,300 in 2023. If those same people held their investments for one year or less, their realized gains would be taxed at the 22% and 35% rates respectively.
An investor may also choose to wait to sell investments if gains realized late in the year would place them in a higher tax bracket and, thus, increase their tax burden. That investor may be better off waiting until January to sell, at which point they can incorporate that profit into their tax plan for the year.
When there are unrealized gains present, it usually means an investor believes the investment has room for higher future gains. Otherwise, they would sell now and recognize the current gain.
Recording Unrealized Gains
Unrealized gains are recorded differently depending on the type of security. Securities that are held to maturity are not recorded in financial statements, but the company may decide to include a disclosure about them in the footnotes of its financial statements.
Securities that are held for trading are recorded on the balance sheet at their fair value, and the unrealized gains and losses are recorded on the income statement.
The increase or decrease in the fair value of held-for-trading securities impacts the company’s net income and its earnings per share (EPS). Securities that are available for sale are also recorded on a company’s balance sheet as an asset at fair value. However, the unrealized gains and losses are recorded in comprehensive income on the balance sheet.
Unrealized Gain vs. Unrealized Loss
The opposite of an unrealized gain is an unrealized loss. This type of loss occurs when an investor holds onto a losing investment, such as a stock that has dropped in value since the position was opened. Similar to an unrealized gain, a loss becomes realized once the position is closed at a loss.
Unrealized gains and unrealized losses are often called ‘paper’ profits or losses since the actual gain or loss is not determined until the position is closed. A position with an unrealized gain may eventually turn into a position with an unrealized loss as the market fluctuates and vice versa.
Example of an Unrealized Gain
If an investor purchased 100 shares of stock in ABC Company at $10 per share, and the fair value of the shares subsequently rises to $12 per share, the unrealized gain on the shares still in their possession would be $200 ($2 per share x 100 shares). If the investor eventually sells the shares when the trading price is $14, they will have a realized gain of $400 ($4 per share x 100 shares).
Related Terms: capital gain, unrealized loss, realized gain, investment portfolio, held-to-maturity securities.
References
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023”.
- Internal Revenue Service. “Rev. Proc. 2021-45”, Pages 8-9.
- Internal Revenue Service. “Rev. Proc. 2022-38”, Pages 8-9.
