Investing can be a powerful tool for building wealth, but it comes with its own set of financial and tax considerations. One term investors often hear is “unrealized gains.” But what does it mean, and how does it impact your financial strategy?
In this article, we’ll break down what unrealized gains are, how they differ from realized gains, and what you need to know about their tax implications.
1. Understanding Unrealized Gains
An unrealized gain occurs when the value of an asset (such as stocks, real estate, or cryptocurrency) increases but has not yet been sold. These gains exist only on paper because no transaction has taken place to “realize” the profit.
For example, if you purchased stock for $5,000 and its current market value rises to $7,500, you have a $2,500 unrealized gain. However, unless you sell the stock, you won’t pay taxes on this gain.
2. Unrealized Gains vs. Realized Gains
The key difference between unrealized and realized gains is whether the asset has been sold:
- Unrealized Gains: Profits that exist on paper but have not been cashed out. These are not taxable until sold.
- Realized Gains: Profits that are locked in when you sell the asset. These are subject to capital gains tax.
3. Why Investors Keep Unrealized Gains
Many investors choose to hold on to assets with unrealized gains for several reasons:
- Tax Deferral: No taxes are owed until gains are realized, allowing investments to grow tax-free until sold.
- Long-Term Capital Gains Benefits: Holding an asset for over a year qualifies it for lower long-term capital gains tax rates (0%, 15%, or 20% instead of ordinary income tax rates).
- Portfolio Growth: Keeping investments compounding over time can maximize returns.
4. How Unrealized Gains Affect Taxes
While you don’t pay taxes on unrealized gains, they can still have indirect tax implications:
- Net Worth and Estate Taxes: If you hold significant unrealized gains, they may contribute to your estate’s total value, potentially triggering estate tax liabilities.
- Wash Sale Rule: If you sell an investment at a loss and repurchase it within 30 days, the IRS disallows the loss for tax purposes.
- Tax-Loss Harvesting: Selling underperforming assets to offset realized gains is a common strategy.
5. Should You Realize Gains or Hold?
Deciding whether to cash out an investment depends on your financial goals:
- Sell if: You need liquidity, want to rebalance your portfolio, or anticipate a tax rate increase.
- Hold if: You want to defer taxes, benefit from long-term growth, or avoid triggering capital gains taxes.
Understanding unrealized gains is essential for smart tax and investment planning. By strategically managing when and how to realize gains, investors can minimize their tax burden and maximize wealth.
Need help with investment-related tax planning? Contact us today for expert guidance!
