Realized and unrealized gains are both important concepts in investing, but they have distinct meanings and implications for accounting and taxes. The key difference between realized gain vs unrealized gain is whether you have sold the asset that has increased in value:
- Realized gain is the sales price of an asset in excess of the basis of an asset. This is a profit that’s been locked in by selling an asset for more than you paid for it. Realized gain is typically included in income:
- Selling the stock you bought for $10 at $12 would result in a realized gain of $2. Since you’ve sold the investment, you’ve turned that paper profit into actual cash.
- Unrealized gain is the excess of the fair market value (FMV) over the basis—usually the purchase price—of an asset. Unrealized gains exist only “on paper” and are excluded from income:
- Imagine the stock you bought at $10 is now worth $12. You have an unrealized gain of $2 because you haven’t cashed in on the investment by selling the stock. It is a potential profit but not a guaranteed one.
Unrealized Gain | Realized Gain | |
|---|---|---|
Scenario | An asset you own has gone up in value but since you still own the asset, your potential profit might be lost if the asset goes back down in value. You haven’t secured the profit. | You sell the asset, thus securing your profit regardless of what happens to the value of the asset in the future. The profit is yours. |
Formula | Current Market Value minus Original Investment | Selling Price minus Original Investment |
No, except for trading securities | Yes | |
Inclusion in Taxable Income | No | Yes, unless excluded by special provision |
Certainty | Requires estimate of FMV | Yes |
Investment Sold | No | Yes |
Profit Guaranteed | No | Yes |
Tax Rate | N/A | Depends on the type of asset sold |
Examples of Realized vs Unrealized Gains
Realized Gains
Let’s say you purchase 100 shares of WidgetCorp’s stock at $20 per share, investing a total of $2,000. A few months later, the company does well and the stock price increases to $25 per share. At this point, the current market value of your investment is 100 shares × $25 per share, or $2,500. Suppose you decide to sell your 100 shares of WidgetCorp stock after the price increase.
If you decide to sell all your shares, here’s how the realized gain is calculated:
- Selling price per share: $25
- Number of shares sold: 100
- Total selling price: $25 per share × 100 shares = $2,500
- Original investment: $2,000
- Realized gain: $2,500 (selling price) – $2,000 (original investment) = $500
In this scenario, you have sold your investment and secured a profit. The $500 difference between the selling price and your original investment is your realized gain. Since the realized gain is on stock, a capital asset, this realized gain will be taxed as capital.
Unrealized Gains
Continuing with the WidgetCorp example, let’s say you decide not to sell your shares after the price increase. At this point:
- The current market value of your investment is 100 shares × $25 = $2,500
- Your original investment was $2,000
The unrealized gain in this scenario is:
$2,500 (current market value) – $2,000 (original investment) = $500
Therefore, you have an unrealized gain of $500 in this scenario. This gain is unrealized because you haven’t sold your shares yet. If you were to sell the stock at the current market price of $25 per share, you would realize a $500 gain. Until then, it remains an unrealized gain because it exists only on paper.
Recording Realized Gain or Loss Journal Entry
Here’s the basic structure for a journal entry recording a realized gain or loss on an asset.
For a Realized Gain:
- Debit: Cash/notes receivable
- Credit: Asset account/accumulated depreciation (if applicable)
- Credit: Realized gain on asset
Explanation:
- Debit: This side reflects the cash or receivable received from selling the asset.
- Credit: The first credit reduces the book value of the asset being sold. This could be a land account, building account, equipment account, or investment account, depending on the asset type. If you’re selling a depreciable asset, you’ll also need to debit accumulated depreciation to remove it from the balance sheet:
- The second credit recognizes the realized gain on the sale. This account specifically tracks gains from asset sales.
For a Realized Loss:
- Debit: Cash/notes receivable
- Credit: Asset account/accumulated depreciation (if applicable)
- Debit: Realized loss on asset
Explanation:
- The structure remains the same except for the debit to the realized loss account on this side. This reflects the loss incurred from selling the asset for less than its book value.
Recording Unrealized Gain or Loss Journal Entry
Gains are typically not recorded in our accounting records until the gain is realized. Therefore, unrealized gains and losses typically don’t involve journal entries directly affecting the income statement. The market value might fluctuate, so it’s not a guaranteed gain or loss until the asset is sold.
As an alternative, some companies might choose to disclose estimated unrealized gains or losses in footnotes or supplementary reports to provide additional context.
Are Realized Gains Taxable?
Yes, realized gains are usually taxable—unless a specific tax code allows for the realized gain to be excluded or deferred (as in a home sale exclusion or like-kind exchange). Realized gains apply to profits earned by selling investments or assets for more than you paid for them. The sale triggers what is called a taxable event, meaning you will owe tax on the profit.
There are different tax rates depending on the type of asset and how long you held the investment before selling. For example, short-term capital gains (held less than a year) are typically taxed at your ordinary income tax rate, while long-term capital gains (held more than a year) may benefit from a lower tax rate.
Are Unrealized Gains Taxable?
No, unrealized gains are not subject to tax. The 16th Amendment to the United States Constitution gives the government the authority to “… collect taxes on income …” and courts and Congress have both defined “income” to mean realized income—not unrealized income.
Realized vs Unrealized Loss
As with gains, the key difference between realized vs unrealized losses depends on whether you have sold the asset:
- Realized loss is a confirmed loss that occurs when you sell an investment for less than what you paid for it:
- Suppose a popular restaurant chain purchases a prime location in a busy downtown area. However, due to change in customer preferences and rising operational costs, the restaurant struggles to turn a profit. The company decides to close the location and sells their building. The sales price might be less than the adjusted book value of the building. This is a realized loss for the restaurant chain because they’ve sold the building.
- Unrealized loss refers to a potential loss on an asset that you still hold:
- Say a developer constructs a large shopping mall in a suburban area anticipating continued population growth and strong retail demand. However, due to a shift to online shopping and changing demographics, the mall struggles to attract tenants. The vacancy rate increases and overall market value of the mall dips. This is an unrealized loss because the mall hasn’t been sold. The developer might consider strategies like attracting new types of business, renovations, or even converting the space to mixed-use with residential units to potentially recover or even increase the value.
Realized Capital Gain vs Realized Capital Loss
Realized capital gain and realized capital losses are realized gains and losses as previously discussed—but on capital assets. Capital assets include all personally-owned and business-owned assets except inventory and property used in the business like buildings and machinery.
Realized capital gains and losses are included in book income just as any other realized gains and losses. GAAP doesn’t recognize a difference between ordinary and capital assets.
For taxes, realized capital gains are generally included in income. Meanwhile, realized capital losses can be deducted from taxable income—but only to the extent that capital gains are included in taxable income.
Frequently Asked Questions (FAQs)
An unrealized gain is an increase in the value of an asset that you haven’t sold. It is a profit that exists on paper only. Because you haven’t sold the investment, you don’t owe any capital gains taxes on the unrealized gain.
A capital gain is one type of realized gain. Capital gains occur when gains are realized on capital assets, such as personally owned assets and business-owned assets not used directly in the operation of the business.
Yes, that is a realized gain. The equipment was sold for more than its book value (depreciated amount), resulting in a profit,
Unrealized gains can be a factor in strategic business decisions. For example, if a building’s value has increased, it can be used as collateral for a larger loan. Also, knowing the potential value of underutilized machinery might strengthen your hand when negotiating a lease or sale. In some cases, selling a depreciated asset at a gain can offset capital losses from other investments, potentially reducing tax liability.
Bottom Line
Understanding the difference between realized vs unrealized gains is crucial for proper accounting. Unrealized gains offer a glimpse into the potential growth of your portfolio, but they are not guaranteed and are usually excluded from either book or taxable income. Meanwhile, realized gains solidify your profits and can have tax implications.
