- Unrealized Profits and Losses are the profits and losses that haven’t been converted into cash.
- Unrealized Losses cannot be used to reduce Tax Liability.
The increment in the value of any investment be it stocks, bonds, etc. that the investor is holding and hasn’t sold off is termed as “unrealized profit”. Unlike realized profits, which are the profits that are converted into cash, unrealized profits are the profits that haven’t been converted into cash.
For example, Mr. P bought 100 shares of ABC Ltd. at $10 each totaling $1000. After 2 days, his investments rose to $1100, which shows that Mr. P has made a profit of $100. However, his position is still open and he hasn’t sold the shares yet which means the profit hasn’t been converted into cash and hence, will be referred to as Unrealized Profit.
Unrealized profits are also called “Paper Profits”. This means even though your investments have risen in value, the position has not been sold and you have not received any actual cash. All this gain is practically just on paper without any actualization.
The unrealized profits are not taxed by the Internal Revenue Service (IRS) and can be used as an effective tool for tax planning. As you have not realized your gain, you’re not liable to claim that gain as income. Hence, you can show less income which will automatically reduce your tax liability. But once you realize these profits, it becomes liable for you to pay taxes.
Are Realized Profits Taxable?
Realized Profits can be categorized into short-term (one year or less) and long-term (more than one year) capital gains subject to the year in which the profit was realized. However, an investor can re-invest their capital gains under the conditions that the gain was earned.
What are Unrealized Losses?
The reduction in the value of any investment like bonds, shares, etc. which is still in holding by the investor but hasn’t been sold is termed as “unrealized loss”. In simple words, unrealized loss is a loss that hasn’t been converted into cash.
For example, Ms. Q bought 50 shares of D Ltd. at $100 each totaling $5000. After a week, her investment value fell to $4500, which shows that Ms. Q had to bear a loss of $500. But she hasn’t sold her shares yet, which means her position is still open and the loss hasn’t been converted into cash, hence, this loss will be referred to as an “Unrealized Loss”.
Can Realized Losses be Used to Reduce Tax Liability?
Realized losses, which can be used as a tool to offset capital gains, unrealized losses cannot be used in any such manner because unrealized gains are not taxed which means no actual cash income has been received.
If an individual doesn’t have capital gains to set off their capital losses, in that case, the United States Government allows that individual to take benefit from that loss by allowing them to set off up to $3000 of that loss against their ordinary income.
