What Is an Unrealized Gain?
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. It is possible that if an unrealized gain is not sold in time that the potential profit could be erased if the position loses its profit value before it is sold.
- An unrealized gain is a theoretical profit that exists on paper, resulting from an investment that has not yet been sold for cash.
- Unrealized gains are recorded on the financial statements differently depending on the type of security, whether they are held-for-trading, held-to-maturity, or available-for-sale.
- Gains do not affect taxes until the investment is sold and a realized gain is recognized.
- If an investment is held for longer than a year, the profit is taxed at the capital gains tax rate.
- An unrealized loss is the opposite of an unrealized gain where an investment has decreased in value but has not yet been sold.
How an Unrealized Gain Works
An unrealized gain occurs when the current price of a security is higher than the price the investor initially paid for the security, net of brokerage fees. Many investors calculate the current value of their investment portfolios based on unrealized values. In general, capital gains are taxed only when they are sold and become realized.
When unrealized gains are present, it usually means an investor believes the investment has room for higher future gains. Otherwise, they 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, their 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, they can sell the stock in January of a proceeding year rather than selling in the current year.
Recording Unrealized Gains
Unrealized gains are recorded differently depending on the type of security. Securities that are held-to-maturity are not recorded in the financial statements, but the company may decide to include a disclosure about them in the footnotes to the financial statements.
Therefore, the increase or decrease in the fair value of held-for-trading securities impacts the company's net income and its earnings-per-share (EPS). Securities that are available-for-sale are also recorded on a company's balance sheet as an asset at fair value. However, the unrealized gains and losses are recorded in comprehensive income on the balance sheet.
Unrealized Gain vs. Unrealized Loss
The opposite of an unrealized gain is an unrealized loss. This type of loss occurs when an investor holds onto a losing investment, such as a stock that has dropped in value since the position was opened. Similar to an unrealized gain, a loss becomes realized once the position is closed for a loss.
Unrealized gains and unrealized losses are often called "paper" profits or losses since the actual gain or loss is not determined until the position is closed. A position with an unrealized gain may eventually turn into a position with an unrealized loss as the market fluctuates and vice versa.
Example of an Unrealized Gain
If an investor purchased 100 shares of stock in ABC Company at $10 per share, and the fair value of the shares subsequently rises to $12 per share, the unrealized gain on the shares still in their possession would be $200 ($2 per share * 100 shares). If the investor eventually sells the shares when the trading price is $14, they will have a realized gain of $400 ($4 per share * 100 shares).