What Is a Realized Gain?
A realized gain results from selling an asset at a price higher than the original purchase price. It occurs when an asset is sold at a level that exceeds its book value cost.
While an asset may be carried on a balance sheet at a level far above cost, any gains while the asset is still being held are considered unrealized as the asset is only being valued at fair market value. If selling an asset results in a loss, there is a realized loss instead.
- A realized gain is when an investment is sold for a higher price than where it was purchased.
- Realized gains are often subject to capital gains tax. Depending on the holding period it will be considered either a short-term or long-term gain.
- If a gain exists on paper but has not yet been sold, it is considered an unrealized gain.
How Realized Gains Work
Realized gains and unrealized gains vary considerably. An unrealized gain most often refers to a gain reported on a company’s financial statements and will appreciate the value of the specified asset on a company’s books. Unrealized gains are typically not taxed. They add to an asset’s originally reported book value at the time of purchase and can occur on all types of assets and investments held by a company.
The assets are included on the company’s balance sheet; however, they may be reported with or without the unrealized gains. Unrealized gains for an asset can help to determine its selling price since these gains are added to the asset’s book valuation.
An asset’s value, held on the company’s books, most often includes the total unrealized gain for which it has received and appreciated above its originally booked price. However, unrealized gains may sometimes be off-balance sheet accruals allowing the asset to remain at book value until a sale.
Balance Sheet Elimination
The sale of an asset takes place when a company chooses to eliminate it from the balance sheet. Asset sales can occur for various reasons and purposes and are reported on the financial statements of a company during the period in which the asset sale takes place.
Asset sales are regularly monitored to ensure the asset is sold at fair market value or arm’s length price. This regulation ensures companies are valuing the sale appropriately in the marketplace and takes into consideration whether the asset is sold to a related or unrelated party.
When an asset is sold, a realized profit is achieved, and the firm predictably sees an increase in its current assets and a gain from the sale. The realized gain from the sale of the asset may lead to an increased tax burden since realized gains from sales are typically taxable income, while unrealized gains are not taxable income. This is one drawback of selling an asset and turning an unrealized "paper" gain into a realized gain.
In most business cases, companies do not incur any tax until a realized and tangible profit occurs.
Realized vs. Unrealized Gains
While realized gains are actualized, an unrealized gain is a potential profit that exists on paper, resulting from an investment. It is an increase in the value of an asset that has yet to be sold for cash, such as a stock position that has increased in value but still remains open. A gain becomes realized once the position is sold for a profit.
When unrealized gains present, it usually means an investor believes the investment has room for higher future gains. Otherwise, he would sell now and recognize the current gain. Additionally, unrealized gains sometimes come about because holding an investment for an extended time period lowers the tax burden of the gain.
For example, if an investor holds a stock for longer than one year, his tax rate is reduced to the long-term capital gains tax. Further, if an investor wants to move the capital gains tax burden to another tax year, he can sell the stock in January of a proceeding year, rather than selling in the current year.
Investors should also note the distinction between realized gains and realized income. Realized income refers to income that you have earned and received, such as income from wages or a salary as well as income from interest or dividend payments.