Unrealized Gain

Unrealized Gain

An unrealized gain (a “paper gain”) is the increase in the value of an asset that an investor still holds and has not sold. It exists on paper as the difference between current market value and the original purchase price (including purchase fees). The gain becomes realized only when the asset is sold for a profit.

Key points

• Unrealized gains represent potential, not actual, profit.
• They generally are not taxable until realized; tax treatment depends on how long the asset was held and local tax rules.
• Accounting treatment varies by the type of security (held-to-maturity, trading, available-for-sale).
• An unrealized gain can turn into an unrealized loss if the asset’s market value falls.

How unrealized gains work

When the market price of a security exceeds an investor’s purchase price, the investor has an unrealized gain. Investors may hold assets with unrealized gains to:
* Defer taxes (long-term capital gains frequently receive lower tax rates than short-term gains taxed as ordinary income).
* Continue participating in potential future appreciation.

Tax consequences:
* Short-term gains (assets held one year or less) are typically taxed as ordinary income.
* Long-term gains (assets held more than one year) are taxed at preferential capital gains rates (commonly tiered rates such as 0%, 15%, and 20%, but thresholds and rates vary by jurisdiction and year).
* Timing sales can affect tax brackets and overall tax bills, so investors sometimes delay realizing gains into a different tax year.

Recording unrealized gains in financial statements

Accounting treatment depends on classification:
* Held-to-maturity: Generally not recorded at fair value on the balance sheet; disclosures may appear in footnotes.
* Held-for-trading: Recorded at fair value on the balance sheet; unrealized gains and losses flow through the income statement and affect net income and earnings per share.
* Available-for-sale (or similar classification): Recorded at fair value on the balance sheet, but unrealized gains and losses are recorded in other comprehensive income (OCI) until realized.

Example

An investor buys 100 shares at $10 each. If the market price rises to $12 and the investor holds:
* Unrealized gain = ($12 − $10) × 100 = $200.
If the investor later sells at $14:
* Realized gain = ($14 − $10) × 100 = $400.

Exceptions and special situations

• Realization principle: Income is typically taxed only when received, which is why unrealized gains are usually not taxed.
• Mark-to-market rules: Certain taxpayers or institutions (e.g., traders who elect mark-to-market accounting) may recognize and be taxed on unrealized gains.
• Wealth taxes: Some jurisdictions levy taxes on net worth that can effectively tax unrealized appreciation.
• Step-up in basis: On inheritance in some systems, assets receive a new cost basis equal to market value at death, which can eliminate unrealized gains for heirs.
• Non-taxable ways to avoid realizing gains: donating appreciated assets to qualified charities or holding investments in certain tax-advantaged accounts (e.g., Roth IRAs in the U.S.) where growth is not taxed on withdrawal under qualifying conditions.

Unrealized gain vs. unrealized loss

An unrealized loss is the flip side: the asset’s current market value is below its purchase price. Both are “paper” changes until the position is closed. Market movements can convert unrealized gains into unrealized losses and vice versa.

Bottom line

Unrealized gains reflect potential profit while an asset is still held. They are central to portfolio valuation and tax planning because they affect decisions about when to sell, but they do not become actual, taxable income until realized—except in certain accounting or tax circumstances. Consider accounting classification and tax rules when evaluating whether to hold or sell appreciated assets.