A:

When buying and selling assets for profit, it is important for investors to differentiate between realized profits and gains, and unrealized or so-called "paper profits".

Simply put, realized profits are gains that have been converted into cash. In order words, for you to realize profits from an investment you've made, you must receive cash and not simply witness the market price of your asset increase without selling. For example, if you owned 1,000 common shares of XYZ Corporation, and the firm issued a cash dividend of $0.50 per share, you would realize a profit of $500 from your investment. This is a realized profit because you have received the actual cash, which cannot be lost due to changes in the marketplace.

Similarly, let's say you purchased your 1,000 XYZ shares at $10 per share, for a total investment of $10,000. If XYZ Corp. were presently trading on the market for $15 per share and you sold all of your 1,000 shares on the open market at $15, you would realize a gain of $5,000 on your investment ($15,000 - $10,000).

Now, suppose that XYZ Corp.'s shares were trading at $15, but you believed they were fairly valued at $20 per share, and therefore, you were not willing to sell at $15. Because you would still be holding on to all of your 1,000 shares, you would have an unrealized, or "paper", profit of $5,000. Of course, if you have not closed out of your position and realized your gain, you could still lose some, or all, of your profits - and your principal as well.

On the other hand, because you have not realized your profit, you are not required to claim the gain as income; thus, by holding your shares instead of selling, you can potentially defer taxable income for a year (or many). Of course, the reverse is true for losses - realized losses can usually be claimed by investors as capital losses, offsetting other capital gains, while paper losses can not.

To learn more about profit realization and its implications for investors, check out Selling Losing Securities For A Tax Advantage, A Long-Term Mindset Meets Dreaded Capital-Gains Tax and Tax Tips For The Individual Investor.

RELATED FAQS
  1. What are unrealized gains and losses?

    An unrealized loss occurs when a stock decreases after an investor buys it, but he or she has yet to sell it. If a large ... Read Answer >>
  2. Are my 2015 unrealized capital gains and dividends on mutual funds taxable income?

  3. How are capital gains calculated when using an online brokerage account?

    Are capital gains calculated annually or on every trade? How can selling a stock at a loss save me money on taxes? Also, ... Read Answer >>
  4. How do I calculate the capital gains tax on the sale of my house?

    I'm thinking of selling my first house, but I just learned that I might have to pay capital gains taxes. I wanted to ... Read Answer >>
  5. How do I calculate my gains and/or losses when I sell a stock?

    To begin, you need to know your cost basis, or the price you paid for the stock. If you did not record this information, ... Read Answer >>
  6. How can I tell if I'm an emotional investor?

    Successful investors possess the important trait of emotional stability, which means that they base their investment decisions ... Read Answer >>
Related Articles
  1. Managing Wealth

    Explaining Unrealized Gain

    An unrealized gain occurs when the current price of a security exceeds the price an investor paid for the security.
  2. Personal Finance

    Capital Gains Tax 101

    Find out how taxes are applied to your investment returns and how you can reduce your tax burden.
  3. Retirement

    To Sell Or Not To Sell

    Learn some tips on how to exit a position to the best of your advantage.
  4. Financial Advisor

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  5. Managing Wealth

    Stashing Your Cash: Mattress Or Market?

    Pulling your money out of the market may help you sleep at night, but is it a smart move?
  6. Financial Advisor

    How to Protect Your Portfolio from a Market Crash

    Although market crashes are usually bad news for your portfolio, there are several ways to minimize losses or even profit outright from market movement.
  7. Retirement

    Tax Tips For The Individual Investor

    We give you seven guidelines to help you keep more of your money in your pocket.
  8. Trading

    10 Tips To Clear Your Portfolio's Dead Weight

    Clear the dead weight from your office, your portfolio and your mind to make room for profits.
  9. Investing

    Run Your Finances Like A Business

    Think of yourself as your own little company. To make it run smoothly, you need to take a look at your books.
  10. Investing

    What Are Unrealized Gains And Losses?

    Gains or losses become “realized” when the stock is sold.
RELATED TERMS
  1. Unrealized Gain

    A profit that exists on paper, resulting from any type of investment. ...
  2. Lock In Profits

    Realizing the gains of a position, such as buying a stock, by ...
  3. Unrealized Loss

    A loss that results from holding onto an asset after it has decreased ...
  4. Paper Profit (Paper Loss)

    Unrealized capital gain (or capital loss) in an investment. It ...
  5. Realized Gain

    A gain resulting from selling an asset at a price higher than ...
  6. Amount Realized

    The gain or loss resulting from a sale of an asset. The amount ...
Hot Definitions
  1. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  2. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  3. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  4. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  5. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  6. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
Trading Center