The goal of investing is to earn a profit. You buy a stock at $20 per share and hope its value will increase so you can sell it for more money down the road. Unfortunately, making money from your investments also has some tax consequences.
Knowing how capital gains are taxed ahead of time is critical. It can help you decide how long to hold an investment, when it’s time to sell, and how much you should set aside for Uncle Sam when it comes time to file your tax return.
In this guide, we’ll address the often-misunderstood concept of unrealized capital gains, including how they are taxed and how to deal with them.
How Capital Gains Are Taxed
A capital gain occurs when you sell an asset for more than you bought it. For example, if you buy stock for $10 per share and sell it for $15 per share, you’ve experienced a capital gain of $5 per share.
Capital gains are a great thing for an investor, but they also come with some tax consequences, since the IRS wants its fair share.
The amount you’ll pay in capital gains taxes depends primarily on how long you held an asset. If you hold an asset for less than one year and sell for a capital gain, the difference between your purchase price and your sale price will be subject to short-term capital gains taxes. Short-term capital gains are taxed at your ordinary tax rate. In 2022, those rates range from 10% to 37%.
If you hold an asset for more than one year before you sell for a capital gain, you’re eligible for a more favorable long-term capital gains tax. The rate you’ll pay depends on your income and tax filing status. The table below shows the long-term capital gains rates and who pays each rate.
Tax Rate
Single
Married Filing Jointly
Head of Household
Married Filing Separately
0%
$0 to $41,675
$0 to $83,350
$0 to $55,800
$0 $41,675
15%
$41,676 to $459,750
$83,351 to $517,200
$$55,801 to $488,500
$41, 676 to $258,600
20%
$459,751 or more
$517,201 or more
$488,501 or more
$258,601 or more
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Are Unrealized Gains Taxed?
Capital gains can be either realized or unrealized. After all, asset prices change constantly, and the financial impact on you doesn’t occur until you actually sell the asset. A realized capital gain occurs when an asset’s price is higher than you bought it for and you sell the asset.
If an asset’s price has increased and you haven’t sold it yet, you have an unrealized capital gain. For example, you buy a stock at $10 per share and the trading price rises to $15 per share. Your investment account balance will reflect the change, but because you haven’t sold the asset, you have an unrealized capital gain.
The good news for investors is you won’t be subject to capital gains taxes on unrealized capital gains. It’s not until you sell the asset that a tax consequence applies. As a result, investors can buy assets and hold them for many years without being subject to capital gains taxes (though you may be subject to other taxes, such as those on your dividend earnings).
What Are Unrealized Losses?
An unrealized loss is when you hold an asset that’s gone down in value since you bought it. Just like with capital gains, the loss isn’t realized until you sell the asset. As long as you still own it, the loss has only occurred on paper.
Unrealized losses are an entirely normal part of investing. The stock market doesn’t go up constantly. There will be days, weeks, or even months when the assets in your portfolio lose value. The good news is that the stock market has recovered from every downturn in history, so you can generally assume that losses won’t last forever.
It’s easy to panic when you see you’ve lost money on your investments. As a result, some investors make emotional decisions and sell their falling assets, locking in their losses. Unless there’s a clear purpose behind selling an asset for a loss, it’s considered best to avoid doing so.
How Are Unrealized Gains Accounted For?
Just because capital gains don’t have tax consequences doesn’t mean you shouldn’t be aware of them. As an investor, it’s helpful to have a detailed record of your investments, along with their performance, so you can see whether you’re on track to reach your financial goals.
First, you can see your unrealized capital gains at any time by checking your brokerage account. You’ll be able to see the current asset price, as well as your rate of return for a chosen period.
You can also use a third-party tool to track your gains. For example, the Personal Capital financial dashboard makes it easy to check in on your investments, see your performance, and more.
How to Deal with Unrealized Losses
As we mentioned, you don’t have to worry about losing money on your investments until you’ve actually sold them, locking in your losses. However, you may decide to strategically sell an asset and realize your losses to get a tax benefit.
As we mentioned, the IRS taxes capital gains. However, those gains can be offset by capital losses. For example, if you sell one asset for a $1,000 gain and another for a $1,000 loss, they cancel each other out and you’re left with no tax consequence.
Not only can you cancel out capital gains with losses, but you can actually claim more losses than gains. The IRS allows you to deduct up to $3,000 per year in capital losses ($1,500 for married couples filing separately) to offset taxable income. This reduces your tax burden for the year. Any unused capital losses in excess of $3,000 (or $1,500 for married couples filing separately) is eligible to be carried forward and used to offset capital gains in the future.
This strategy of selling underperforming assets to offset losses is called tax-loss harvesting. It’s a legal investing practice, but you can’t buy back the same stock within 30 days. According to the IRS wash-sale rule, you can’t reenter a substantially identical position either 30 days before or 30 days after selling an asset for a loss.
Can I Avoid My Unrealized Capital Gains Tax?
At this time, there are no tax consequences for unrealized capital gains. This is good news for investors since it means you can easily avoid capital gains taxes by holding onto your assets.
Of course, you’ll eventually reach the point where you want to sell the asset — likely when you’ve reached whatever financial goal you’re planning to use the funds for. In that case, there are still ways to reduce your avoid capital gains taxes. We’ve already talked about using capital losses to offset capital gains. You can also avoid capital gains taxes by holding appreciable assets in your tax-advantaged retirement account rather than in a brokerage account.
It’s important to note that while there’s no current tax on unrealized capital gains, that may not always be the case for some investors. When President Joe Biden introduced his 2023 fiscal budget, it included a tax on unrealized capital gains for investors with a net worth of more than $100 million. This proposal has been unsuccessful so far, but that doesn’t mean it won’t gain more support in the future.
The good news is that since the proposal only applies to very wealthy individuals, most investors won’t have to worry about being taxed on their unrealized capital gains.
Key Takeaways
Capital gains — meaning earnings from selling an asset for more than you bought it — are taxable under federal tax law.
The capital gains tax only applies to realized capital gains. If you don’t sell the asset, you have an unrealized capital gain, which isn’t subject to taxes.
Unrealized losses occur when an investment you hold has lost money, but you don’t realize the loss until you sell the asset.
You can turn unrealized capital losses into realized capital losses to offset realized capital gains and reduce your tax burden.
Next Steps
Managing your investments and their tax consequences is easier when you have the right tools by your side. The Personal Capital financial dashboard provides a variety of free tools to help you manage your portfolio, including a retirement planner, investment checkup tool, and fee analyzer. If you need additional help with your investments, you can connect with an advisor who can provide personalized advice when it comes to maximizing your earnings and reducing your taxes.
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