How are realized profits different from unrealized or so-called "paper" profits?

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October 2016
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Hi! The other answers here are great, and I wanted to add a thought about how taxes work on unrealized and realized gains. People buy stocks for several reasons including capital appreciation (which occurs when a stock rises in price) and dividends (which are payments made to stockholders when the company distributes some of its earnings to stockholders). So “capital gains” are when you realize capital appreciation by selling the stock. You only take a capital gain in a stock when you actually sell it, and that’s the only time you pay taxes on what you’ve earned. Clients have asked me if they need to pay taxes on a stock that’s appreciated in a year or as in your question, on a stock that shows a "paper profit."  In other words, if you spend $1,000 on ABC stock in Jan. 2015 and then at the end of the year the stock has gone up and it is worth $2,000, would you owe the IRS tax on the $1,000 you’ve made that year? In the case of this "paper profit," you wouldn’t owe any tax on the amount you’ve earned so far in 2015 because you haven’t actually realized or locked in that gain. A company you own stock in could feasibly go bankrupt at any moment, so the $1,000 profit you have on paper could disappear and instead of your ABC stock being worth $2,000, it could be worth 0. That’s why you don’t pay taxes on that stock's paper profit – at any moment as the stock market moves and as your stock price moves, your profit changes. It’s only when you sell the stock for more than you paid for it that you realize a capital gain…or a loss when you end up selling it for less than you paid for it or if the company goes bankrupt. Thanks so much for writing to us!

October 2016
October 2016
April 2006