Brokers will send you a statement every month of any trading activity. But for those who want to keep track of investment gains in real-time, it’s necessary to record those gains. For real estate transactions, investors are used to recording them as they happen since there’s no brokerage involved. We’ll look at how to record realized gains and why keeping track of unrealized gains helps complete the gains picture.
Recording Realized Gains
Realized gains represent completed investment transactions, which means an investment was purchased and sold. This is a gain if a profit is made, and taxes may be due. If the investment was sold for a loss, the investor might be able to receive credit against taxes owed.
Realized gains come in two forms — short and long-term. Each is taxed differently. Short-term investment gains are taxed at the investor’s ordinary tax rate. Long-term investment gains are taxed at the capital gains rate.
- Purchase price
= Realized gain or loss
A gain is generated if the sale price exceeds the purchase price. In some cases, the investor may have kept purchasing the same investment at different prices, for example, in the case of a stock. These multiple purchases will create a cost basis or an average price. Rather than a purchase price, the cost basis may be used in the above calculation.
Realized gains also include paid-out dividends, distributions, and interest. Investors receive the details of the previous items on forms 1099-DIV and K-1. These two forms can represent different tax rates. 1099-DIV can have short and long-term dividends and qualified dividends, which are taxed at a lower rate than ordinary income. A K-1 is used when there are distributions from a business, which can be taxed at the ordinary income rate.
1099-DIVs are usually sent at the beginning of the following year in which dividends were paid out. K-1s don’t have a set schedule and are sent at different times, usually later than 1099-DIVs.
When recording a realized gain, it is simply a matter of entering the sale price into an investment account. This closes the transaction for the investment and creates a realized gain.
Recording Unrealized Gains
What happens after an investment is purchased and before it is sold? During this period, investors can keep track of the investment’s value and impact on net worth or business value through unrealized gains.
Unrealized gains or losses reflect the current value of an asset. They represent paper profits or losses. Taxes are not owed on unrealized gains and losses cannot offset taxes owed. Unlike realized gains, unrealized gains do not impact cash flow.
Unrealized gains are reflected on the balance sheet. Specifically, they affect equity. To record unrealized gains, the increase in an investment’s value is recorded to an investment account and charged to “Current Assets - Investments” or some similar equity category.
Unrealized gains can be recorded periodically, such as monthly, quarterly, or bi-annually. The frequency is up to the investor. This type of recording is called mark to market because the asset/investment is being marked to its current market value.
For some more complex investments that are illiquid and may not have a comparable market value, mark to model is used. Mark to model uses a model to determine the investment’s market value.
Recording a realized gain creates cash flow for an investor or business. It may also be a taxable event, depending on other tax offsets. For some investments, a cost basis may be used to calculate profits rather than a single purchase price.