A realized gain refers to the profit earned when an asset is sold for a price higher than its original purchase cost. This gain becomes “realized” when the transaction is completed, distinguishing it from unrealized gains, which exist only on paper until the asset is sold.
Definition and Formula
Mathematically, a realized gain (RG) can be expressed as:
Where:
- Selling Price (SP) is the amount received from selling the asset.
- Purchase Price (PP) is the initial cost of the asset, including any associated purchase fees.
Examples
- Stock Sale Example: Suppose you purchase 100 shares of a company at $10 per share (PP = $1000). Later, you sell these shares at $15 per share (SP = $1500). The realized gain is:
- Real Estate Sale Example: If a property is bought for $200,000 and later sold for $250,000, the realized gain would be:
Comparison with Unrealized Gain
What is an Unrealized Gain?
An unrealized gain represents the increase in the value of an asset that has not yet been sold. It is ongoing and can fluctuate based on market conditions.
Example
If an investor buys stock for $1000 and its current market value is $1500, but the stock hasn’t been sold, the $500 increase is an unrealized gain.
Key Differences
- Realization: Realized gains are confirmed by actual transactions, while unrealized gains are potential increases in value.
- Taxation: Realized gains are typically subject to capital gains tax, whereas unrealized gains are not taxed until the asset is sold.
- Accounting: Realized gains are reported in financial statements under revenues or income, whereas unrealized gains might be noted but not included in net income.
Special Considerations
Tax Implications
The realization of gains triggers tax obligations. The amount and type of tax depend on factors such as the holding period of the asset:
- Short-term Capital Gains: Gains on assets held for one year or less, often taxed at higher rates.
- Long-term Capital Gains: Gains on assets held for more than one year, usually taxed at lower rates.
Investment Strategy
Investors might delay realizing gains to defer tax liability or strategically realize losses to offset gains, reducing their overall tax burden.
Related Terms
- Capital Gains: Profits from the sale of assets or investments.
- Capital Loss: The loss incurred when an asset is sold for less than its purchase price.
- Cost Basis: The original value of an asset for tax purposes, usually the purchase price plus associated costs.
- Fair Market Value (FMV): The price at which an asset would sell in a competitive and open market.
FAQs
1. What happens if the asset value drops before I sell it?
2. How often do I need to report realized gains?
3. Can I offset realized gains with losses?
Summary
A realized gain is a tangible profit earned from selling an asset for more than its purchase price. Comprehending the distinction between realized and unrealized gains is crucial for effective financial management and tax planning. By understanding these concepts, investors can make informed decisions and optimize their investment strategies.
