What is an Unrealized Gain?
An unrealized gain represents the increase in the value of an asset that has not been sold. This concept is often called paper profit.
How Does an Unrealized Gain Work?
Let's assume you own 100 shares of Company XYZ that you purchased for a total of $1,000. If the value of the investment increases to $5,000 but you continue to hold the shares, your unrealized gain equals $4,000 ($5,000 - $1,000).
Why Do Unrealized Gains Matter?
Changes in tax rates may influence the timing of an investor's decision to realize profits. Capital gains are generally only taxable when the asset is actually sold, i.e. when the paper profits are realized. From a tax perspective, realized losses can often offset realized profits and thus lower a person's potential capital-gains taxes.
For companies, the implications of unrealized gains depend on the intentions of the investment. If a company purchases stock in another company primarily for the purpose of selling the stock later it must classify these shares as trading securities and report any unrealized gains or losses in its earnings. However, if the investing company does not intend to sell the stock in the near term, the stock is classified as available-for-sale, and any unrealized gains or losses on the stock are excluded from the investing company's earnings.