Realized vs. Unrealized Gains: Differences and Tax Implications

Realized and unrealized gains represent profits from the sale of assets. However, that’s the only similarity between the two terms. 

These two types of gains vary, impacting tax liabilities and portfolio performances. Understanding the differences between realized and unrealized gains can help you better understand the tax implications as you focus on your investment goals.

Realized Gains: Profit in Hand

A realized gain represents the profit you earn from selling an asset like real estate property. In other words, the difference between the asset’s original purchase price and what you sold it for (minus costs associated with the sale). 

The formula for calculating this type of gain is:

Total profit from a sales price - fees connected to the sale asset’s original value = realized gain

Example: You buy a real estate asset for $10,000. When it’s time to sell, you receive $30,000 less $1,000 in brokerage fees. The calculation would be as follows:

$30,000 (sales price) – $10,000 (original price/cost basis) = $20,000 (profit)

$20,000 (profit) – $10,000 (original price/cost basis) – $1,000 (broker’s commission) = $19,000

Your realized gains would be $19,000. You would be taxed on the gains in the following ways:

• If you hold the asset for a year or less, the gains are taxed as ordinary income (based on your income bracket)
• If you hold the asset for longer than a year, the gains are taxed as capital gains (0%, 15%, or 20%, depending on your income bracket)

If the proceeds from your sold asset are less than what you paid for it, you incur a realized loss rather than a realized gain. You could use up to $3,000 in net losses to offset ordinary income.

Unrealized Gains: Profit on Paper

Unrealized gains, sometimes known as “paper gains,” represent investments that increase in value through appreciation but have yet to be sold. Unrealized gains represent the difference between how much you paid for an asset and its current market value. 

They aren't taxed because there is no physical cash flow tied to unrealized gains. 

Example: You buy a real estate asset for $10,000. Due to value appreciation, that property’s value reaches $35,000 over seven years. Your unrealized gains would be $25,000.

Knowledge is Necessary

The differences between realized and unrealized gains have real-world implications for your investment goals and portfolio planning. Here’s why you need to know the differences:

• Tax implications. You are taxed on realized gains (which are taxed as ordinary income or capital gains, depending on how long you held the asset). Unrealized gains aren’t taxed until you sell the asset.
• Financial reporting. A realized gain ends up on your income statement. Meanwhile, unrealized gains are recorded on your balance sheet under “accumulated other comprehensive income.”
• Investment strategies. Understanding the difference between realized and unrealized gains can help you with tax-advantaged strategies. For example, you could defer taxes on a realized gain through a 1031 exchange as long as:
  • The asset is real estate used for investment or business purposes
  • You find a replacement property of equal or greater value than the one you sold
  • You comply with the IRS’ like-kind exchange rules

To summarize, it’s important to understand how realized versus unrealized gains operate. Knowing the differences is important in helping you manage your portfolio, anticipate taxes, and reach your investment goals.

If you are interested in potentially deferring capital gains taxes from the sale of real estate used for business or investment purposes, contact Realized 1031. The company’s staff offers years of knowledge regarding the process and can help guide you through the necessary steps for a successful exchange.

Visit realized1031.com to schedule your no-obligation consultation.

Examples are used for illustrative purposes only.

The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.