Key Takeaways
- Increase in asset value before sale.
- Represents paper profit, not cash.
- Not taxed until asset is sold.
- Value can fluctuate with market changes.
What is Unrealized Gain?
An unrealized gain is the increase in value of an asset above its original purchase price that you hold but have not yet sold. It represents a "paper" increase in wealth, reflecting potential profit that exists only on paper and not as actual cash.
This gain fluctuates with market prices and only becomes a realized gain when you sell the asset, triggering tax implications.
Key Characteristics
Understanding unrealized gains requires recognizing several key features:
- Calculation: The difference between the current market value and the asset's cost basis, including reinvested dividends if applicable.
- Paper Nature: Often called paper money gains, these profits exist only on statements and can reverse if market prices fall.
- Volatility: Unrealized gains can quickly become unrealized losses if asset values decline below your purchase price.
- Accounting: For some securities, unrealized gains are recorded in accounts such as the T-account under Other Comprehensive Income rather than immediate income.
How It Works
When you buy an asset like shares of SPY or IVV, its market value may increase over time. This increase creates an unrealized gain reflecting potential profit if you choose to sell.
However, unrealized gains are not taxable until realized through a sale. You can monitor these gains to assess your portfolio’s health but should remember they are subject to market volatility and can fluctuate daily.
Examples and Use Cases
Unrealized gains appear in many investment scenarios, helping you track growth without triggering taxes:
- Exchange-Traded Funds: Holding shares in ETFs like BND may show increased market value, creating unrealized gains until sold.
- Stocks: Purchasing shares in SPY that rise in price demonstrates unrealized gains until you decide to liquidate.
- Mutual Funds: Investments in funds with dividends reinvested increase cost basis, affecting how unrealized gains are calculated.
Important Considerations
While unrealized gains indicate portfolio potential, they do not provide actual liquidity or guaranteed profit. It's essential to consider market fluctuations and your investment horizon before making decisions based solely on these gains.
Tracking unrealized gains alongside total return metrics can give a fuller picture of performance. Be mindful of tax timing when planning sales to realize gains or harvest losses strategically.
Final Words
Unrealized gains reflect potential profit but remain vulnerable to market shifts until you sell. Monitor these gains regularly and consider your investment goals to decide the right time for realization.
Frequently Asked Questions
Unrealized gain is the increase in an asset's market value above its original purchase price while the asset remains unsold. It represents a 'paper profit' that hasn't been converted to cash or taxed.
Unrealized gain is calculated by subtracting the cost basis, which includes the original purchase price plus any reinvested distributions, from the current market value of the asset.
Yes, unrealized gains can fluctuate with market conditions and may turn into unrealized losses if the asset's market value falls below its cost basis.
No, unrealized gains are not taxable because there is no actual sale or transaction. Taxes apply only when the gains are realized through selling the asset.
Unrealized gains occur while holding an asset and represent paper profits, whereas realized gains happen after selling the asset and are taxable. Realized gains provide actual cash flow, while unrealized gains do not.
For available-for-sale securities, unrealized gains are recorded in Other Comprehensive Income (OCI) rather than the income statement, reflecting their temporary and non-cash nature.
Tracking unrealized gains helps investors understand their portfolio's potential growth and net worth changes, although these gains can fluctuate and are not guaranteed until realized.
Yes, reinvested dividends increase the cost basis of an asset, which affects the calculation of unrealized gains by potentially reducing the paper profit shown.
