While realized gains and recognized gains may sound similar, they have distinct meanings. The main difference between realized and recognized gain significantly impacts your tax bill:
- Realized gain is the tangible financial benefit you receive when selling an asset for more than its adjusted basis Adjusted Basis is generally the initial cost less accumulated depreciation (if any) . It reflects your overall profit regardless of accounting or tax treatment.
- Recognized gain is the portion of the realized gain that is included in your income. The recognition of realized gains often varies between generally accepted accounting principles (GAAP) income and taxable income.
Realized Gain | Recognized Gain | |
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Formula | Selling price minus adjusted basis | Realized gain minus excluded or deferred gain |
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Tax Obligations |
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Key takeaways
- Recognized gain is the amount used to compute net income and might vary from the realized gain.
- Recognized gain can be lower than the realized gain because of special rules excluding a gain from income.
- Recognized gain is simply a realized gain that is being “recognized” by including the gain in a measure of net income.
- There can be tax-deferred strategies, such as 1031 exchanges in real estate, where the recognized gain for taxable income might be zero if certain conditions are met.
- Realized gain is a broader concept reflecting your overall profit upon the sale of an asset.
- Most realized gains will be immediately recognized; however, sometimes, a realized gain is excluded from income, such as not recognized. For example, GAAP income might exclude realized gains on sales to subsidiaries and taxable income might exclude the realized gain on sale of certain property, such as qualified small business stock.
Examples of Realized & Recognized Gains
Scenario 1
Let’s say your company purchases 100 shares of XYZ stock for $10 per share in 2020. Your total cost is $10 per share × 100 shares = $1,000. In 2024, you decide to sell all of your shares for $200 per share.
Realized gain:
- Selling price per share: $200
- Original purchase price per share: $10
- Realized gain per share: $200 – $10 = $190 profit
- Realized gain total: $190 per share × 100 shares = $19,000
Recognized gain:
- Unless the stock qualifies for a special GAAP provision, the entire $19,000 realized gain will be recognized in book income. For instance, the $19,000 realized gain wouldn’t be recognized in book income if the stock purchased and sold was treasury stock (your company’s own stock).
- The realized gain of $19,000 will also be recognized in taxable income unless a special tax provision allows the gain to be excluded or deferred. If XYZ was qualified as small business stock under Internal Revenue Code section 1202, then none of the $19,000 of realized gain would be recognized.
Scenario 2
Here’s another example, this time focused on real estate. In 2018, your company buys a building for $250,000. You spend $50,000 on renovations and improvements over the next few years and deduct depreciation expense of $21,000. In 2024, you decide to sell the building for $400,000.
Realized gain:
- Selling price: $400,000
- Adjusted basis: $279,000 = $250,000 (purchase price) + $50,000 (improvements) – $21,000 (depreciation)
- Realized gain: $121,000 = $400,000 (selling price) – $279,000 (adjusted basis)
Recognized gain:
- The entire $121,000 realized gain will most likely be recognized in both book income and taxable income.
- However, if instead of voluntarily selling the building it was condemned, then the involuntary conversion rules in the tax code might allow the realized gain to be deferred instead of recognized.
Are recognized gains taxable? Yes, recognizing a gain for tax purposes means including the gain in taxable income. However, recognized gains for book income are not necessarily recognized for taxable income and, therefore, are not necessarily taxable.
Realized vs Recognized Loss
Realized and recognized losses follow a similar concept to recognized and realized gains but are applied to situations where you sell an asset for less than its adjusted basis:
- Realized loss is the actual loss you incur when you sell an asset for a price lower than its adjusted basis:
- It is calculated by adding the purchase price and improvements, minus the depreciation cost.
- It is a simple calculation of the negative profit you make on the sale.
- Regardless of tax or accounting treatment, a realized loss exists if you sell the asset for less than its adjusted basis.
- Recognized loss refers to the portion of the realized loss that you can deduct from your income:
- Not all realized losses are recognized for tax purposes. For instance, realized losses on capital assets generally are only recognized when they can offset recognized gains on capital assets.
Frequently Asked Questions (FAQs)
Both refer to profits made from selling an asset. While a realized gain is the actual profit you make on the sale of an asset, a recognized gain is the portion of the realized gain that is reported in your income. This can differ when rules exist to either defer or exclude realized gains from income.
Recognizing a gain refers to the process of recording a profit you made on an asset in your income. This happens when you sell an investment or asset for more than its adjusted basis, and no special rules allowing the gain to be deferred or excluded exist.
This is a bit of a trick question. The recognized gain on a home sale is taxed as a capital gain. However, the tax code allows homeowners to exclude most or all of the realized gain on a home sale, so very little of the realized gain is recognized.
Bottom Line
Once you understand that “recognized” refers to including a gain in income, the difference between realized and recognized gains becomes clear. Realized gains happen when you sell an asset. Depending on the rules for whatever type of income you are calculating, realized gains might become recognized gains by including them in income.
