Unrealized and realized capital gains are treated very differently on your annual tax return.
Unrealized gains are paper gains, while realized gains are profits generated from the sale of capital assets. Let’s take a closer look at both.
What Are Unrealized Gains?
Unrealized losses or gains are the fluctuating values of capital assets before you sell them. Since these ups and downs haven’t been truly recognized, they are often called paper gains or paper losses – the real price you’ll get for the asset won’t be realized until it’s actually sold.
Another way of looking at it is that unrealized gains are the difference between your basis in an investment and the price you can get when you dispose of it. Say you bought one Bitcoin in early 2019 when the price hovered around $3,800. In April of 2022 that investment is now worth around $40,000, leaving you with an unrealized gain of $36,200.
Investors often hold assets with unrecognized capital gains hoping the value will continue to increase – a rental property in a hot real estate market that’s seen significant appreciation, for instance. Investors also may choose to extend holding times because they don’t want to pay capital gains taxes.
Unrealized gains have no bearing on your taxes because they aren’t actual income; however, if you turn those paper gains into actual profit by selling an investment asset for more than your original basis, you’ll have to report the profit to the Internal Revenue Service.
What Are Realized Gains?
Investors generate realized gains anytime they sell a capital asset for a higher price than its original basis. These gains are subject to capital gains taxes, and how much you’ll pay depends on how long you held the asset.
Short-term capital gains – those held less than one year – are taxed as regular income. You’ll be taxed on short-term gains at your nominal rate, which could be as high as 37 percent for single investors with income exceeding $539,900 in 2022.¹
Long-term capital gains are taxed much differently, however. If you hold an investment for more than a year, you’ll be taxed at 0, 15, or 20 percent depending on your income and tax filing status.
The Bottom Line
Investors with unrealized gains don’t have to worry about paying taxes until they divest capital assets for a higher value than their basis. When that happens, you’ll have to report that income to the IRS, which will tax it as short-term or long-term capital gains depending on how long you held the investment.
Although we’ve covered the basics of unrealized gains, you should consider having a discussion with a qualified tax professional to fully understand your individual tax situation.
Sources:
1. 2022 Tax Brackets, Tax Foundation, https://taxfoundation.org/publications/federal-tax-rates-and-tax-brackets/
