An unrealized capital gain is potential profit on an investment that’s not yet sold.
Capital gains are in the news a lot, as advocates push to have taxes on them either lowered or raised. That’s because it’s income earned from investments, instead of wages or salaries.
Let’s start with defining a capital gain: that’s the profit you get from an investment when you sell it, whether it’s a stock, a bond, real estate or almost any investment. They can also be classified as short term or long term depending on how long you hold the investment.
Unrealized capital gain is your potential profit from an investment before you sell it. That’s why it’s called “unrealized,” because you haven’t actually sold the investment to make it happen yet. A gain becomes “realized” once the sale is completed.
But it’s also possible to have unrealized capital losses. That’s your potential loss on an investment, when it’s value goes down before you sell it.
Unrealized gains and losses are referred to as paper profits or losses since they can't be determined until the sale is completed (or, in stock market talk, when “the position is closed”).
An unrealized gain can also turn into an unrealized loss if the value of your investment changes before it’s sold. Speedy fluctuations in the stock market can do sometimes that.
Under the current tax code, unrealized capital gains are not considered income by the IRS, so they’re not taxed. This means that if you own stocks or real estate that are increasing in value, you’re not required to pay taxes on them until you sell them.
But some advocates and lawmakers propose taxing unrealized capital gains for the super-rich, like billionaires Warren Buffet, Jeff Bezos, Elon Musk and others. Most proposals would no longer allow heirs to inherit assets and avoid paying taxes on those gains until they sell them.
However, if the same law were to apply to everyday investors, it could dramatically impact how much we all earn on ordinary investments.
Capital gains are only taxed when they are sold (or “become realized”), and they’re taxed according to how long you've held the investment.
Investments held for more than 1 year are subject to long-term capital gains tax, which can range from 1% to 20%.
Advocates and lawmakers frequently target these rates, too. One common argument: profits from investments are different from wages or salaries, because they’re earned without labor. If you value wealth derived from labor more, you might advocate for a higher capital gains tax. And if you value wealth from investing in others, you might advocate for a lower capital gains tax.
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With a postgraduate degree in commerce from The University of Sydney, Pranay has his finger on the pulse of the finance industry. Breaking down complex financial concepts is his forte.