Gains and losses are part of life, certainly an inevitable aspect of investing in real estate (or anything else). How investors manage those gains and losses is part of the strategy. When an asset is worth more than you paid for it (your basis), you have a gain, and when it is worth less than your basis, you have a loss. However, that gain or loss is unrealized unless you dispose of the asset. Also, gains and losses are categorized by the IRS as short- or long-term.
The key terms to keep in mind here are the basis, which is the investor’s cost (although if you inherited the asset, special rules apply), realized and unrealized, and short versus long-term gains and losses. Typically, any investment you hold for one year or more before disposing of it is considered long-term, which affects the tax consequences of either a gain or loss. Conversely, any asset you owned for less than a year when you dispose of it results in a short-term gain or loss. Typically, short-term gains and losses are considered together, and gains are subject to the tax imposed at the ordinary income level, usually higher than the capital gains rate. Long-term gains and losses are considered together, and net gains are taxed at the lower capital gains rate.
What Is a Realized Gain or Loss?
Remember, if you have an asset that experiences a value increase or decrease, that fact alone does not result in a realized gain or loss. For example, suppose you own an apartment building that you purchased for $1 million. During the time you own it, the market value increases to $1.5 million, then wanes to $750,000, and then finally rebounds to $1.3 million when you decide to sell. While you had a "paper loss" when the potential sale price declined and a theoretical gain when the price peaked, those were unrealized gains. The realized gain occurred when you sold the property for $300,000 more than your basis.
So, the IRS does not impose taxes on gains that you don’t realize by disposing of the asset. Similarly, you will not have a realized loss if you continue to hold an asset during a period of lower value. However, you "realize" or "recognize" the loss when you sell or otherwise dispose of the property.
Can a Realized Loss Help Me?
Taxpayers can offset capital gains with capital losses. Both must be realized since unrealized gains or losses remain hypothetical until realized. Only long-term losses can offset long-term gains. For example, suppose that you gain $10,000 by holding one asset for a few years and then selling it. Any realized capital losses that you have in the same year can offset that gain to reduce the tax impact (please consult your tax advisor for specific guidance). Now suppose that you incur a capital loss this year but no gain or a gain that is less than the amount of the loss. If you can’t use the entire loss as an offset, the IRS will allow you to save the credit for use in a future year when you have a realized gain to offset.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.