Even if you aren't a long-term investor, you're probably familiar with the concept of gains and losses. From a tax perspective, you don't really have a gain or a loss on an investment until you "realize" it. In other words, you won't "realize" a gain or loss from a capital asset until you sell it. If you sell an asset and you turn a profit, you have a realized gain. But if you sell an asset and you lose money on the deal, you have a realized loss.
You'll have a realized capital gain if you sell a capital asset at a higher price than you purchased or acquired it. You'll have a realized capital loss if you sell a capital asset at a lower price than you purchased or acquired it.
Realized Gain and Loss
To realize a gain or loss means to record it via a sale. If you have a gain on paper but haven't yet sold the asset, you're gain is an unrealized gain. Unrealized gains fluctuate from moment to moment along with the daily market trend, but realized gains are permanent and specific. The same holds true of realized losses, which result from selling an asset at a loss. Once you realize a gain or loss, its value is fixed and cannot be changed.
Short-Term Vs. Long-Term
A short-term gain or loss results when you sell a capital asset one year or less after you purchase it. If you've held an asset for longer than one year, you have a long-term transaction. The differentiation between long-term and short-term gains and losses is important when you file your taxes. Long-term gains typically benefit from a lower tax rate than short-term gains.
Evaluating Current Tax Rates
Realized gains and losses are reported on your taxes and can raise or lower your tax bill, depending on how you use them.
As of 2019, the maximum tax rate on long-term capital gains is 20 percent. For investors in the middle tax bracket, the maximum tax rate is 15 percent, and investors in the lowest tax bracket have zero tax liability.
Short-term gains are taxed as ordinary income. You'll pay the same tax rate on your short-term gains as you would on your wages or salary. Since the top federal tax bracket as of 2019 is 37 percent, a short-term gain would cost you an additional 20 percent in tax over a long-term gain.
Smart Tax Planning
To lower your tax bill, you can use your realized losses to offset any realized gains. If you have additional losses above and beyond your gains, you can take an additional $3,000 per year off your ordinary income for tax purposes. Excess losses can be carried forward for use in the same way in future years. If you have unrealized gains approaching the one-year mark, you may consider holding those assets for a few additional days to cross into long-term territory before you realize them.
John Csiszar has written thousands of articles on financial services based on his extensive experience in the industry. Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to his online work, he has published five educational books for young adults.