The investing world abounds with jargon about investment gains and losses.
Terms like realized gains and losses (as opposed to unrealized gains and losses) are confusing for first time investors, but never fear, we’re breaking it down so you understand exactly what they mean – so you can win at investing!
What Does Realized Mean in Investment Terms?
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In investment jargon, the term “realized” means “real.” It means the gain or loss really happened, and there’s no way to change the outcome.
Realized means a tangible, concrete, absolute gain or loss.
Realized gains typically refer to capital gains or other investment gains. When discussing stock market investing, you may see them described as “realized capital gains.”
You can realize gains in any investment, from real estate to equities to cryptocurrencies. It simply means you made money on an investment and have that money in hand.
But the opposite is also true: you can also realize losses in any type of investment.
What’s the Difference Between Realized and Gain?
Realized is an adjective, while gain is a noun. You can have four different combinations:
- Realized Gains
- Unrealized Gains
- Realized Losses
- Unrealized Losses
The gain or loss describes whether you made or lost money on an investment. The adjectives realized and unrealized describe whether the gain/loss is tangible or conceptual.
What’s the Difference Between Realized and Unrealized Gains?
While realized gains are concrete, unrealized gains are conceptual. They’re paper gains, but they’re not tangible. You can’t hold the money in your hand, and the gains can disappear again with changes in stock prices.
Realized gains and losses often have tax implications that don’t apply to unrealized gains and losses.
What’s a Realized Gain?
A realized gain is real money you make from an investment. You have the cash in hand, and there’s no possible way you can lose it again (unless you decide to reinvest it in a different opportunity).
Realized gains have tax implications. Any money you make while investing must be reported to the Internal Revenue Service (IRS), and you will have to pay capital gains tax on any of your realized gains.
How Do You Realize Gains?
You realize gains by selling an investment for more money than you paid. When you sell an investment, you receive a cash payment from the buyer. That cash payment can go into your checking or savings account, giving you real money in the bank.
Examples of Realized Gains
You can realize gains in any investment opportunity.
Let’s say you buy 1,000 shares of stock for a dollar a piece. You’ve spent $1000 on your investment. The original investment price is called your cost basis. The economy strengthens, and your stock soars to $2 per share. You decide to sell. You’ve made $1000 on your investment, meaning you’ve realized $1000 in capital gains (excluding any brokerage fees you’ve paid to buy/sell).
Some stocks pay dividends, a distribution of earnings to shareholders. Dividends are realized gains because they are tangible. You get the money. Many investors automatically reinvest their dividends, but that doesn’t matter when it comes to whether they’re realized (and taxable!) or not.
Real estate can also yield realized gains. Say you bought a house for $200,000 in 2015 and held it during the price increases of the early 2020s. Now it’s worth $400,000, so you decide to sell. Your realized gains are your profits after paying all the selling fees.
What’s a Realized Loss?
Realized losses are the opposite of realized gains. They’re tangible investment losses that you have no opportunity to recoup.
Realized losses also have tax implications. Many savvy investors use realized losses for tax loss harvesting and to offset their tax liability from realized gains.
How Do You Realize a Loss?
You realize a loss when you sell an investment for less than you paid or when an investment goes belly up, and you have no opportunity to restore any losses.
Examples of Realized Losses
You can realize losses in every investment opportunity, just like gains.
Let’s say the same company you bought 1,000 shares of plummets in value instead. Now, it’s only worth $.5 a share. You sell, not wanting to lose any more money, and you realize a loss of $500.
You can also realize a loss if a company you’ve invested in files for bankruptcy. Let’s say you didn’t want to sell and opted to hold out to see if the company would ever change course. Unfortunately, they don’t- they file for bankruptcy instead. There is no way to recoup your losses, so now you’ve realized a loss of $1000.
Those who bought homes in 2007 and sold them during the crash of 2008 realized losses in the housing market. If you buy a house for $200,000 and are forced to sell for $100,000, the $100,000 difference is a realized loss. Some filed for bankruptcy, as they couldn’t afford to pay such a substantial loss.
Tax Implications of Realized Gains and Losses
Uncle Sam gets a piece of any investment profits you reap. Capital gains are taxed at different rates depending on whether they are short-term or long-term capital gains.
Short-term capital gains refer to gains on investments held for under a year, while long-term capital gains refer to investment gains made on assets held for over a year.
Short-term capital gains have higher tax rates, but the rates depend on your income tax bracket.
Realized gains on real estate have different tax rules. Your tax liability depends on whether you owned the home as an investment property or primary residence and how long you lived there.
Lots of Complex Situations
Though the definition of realized gains is straightforward, the US tax code allows for many exceptions and nuances that can make determining whether your gain is realized or taxable confusing.
Investment gains from Roth IRAs and 401Ks have different rules than those achieved in standard brokerage accounts. Similarly, people withdrawing from their retirement accounts have different rules than people still in the building phase.
Speaking to a tax professional is essential if you don’t understand which gains are reportable during the tax year.
Investing is Complicated But Worthwhile
Don’t let these complex investment terms prevent you from investing in your future. To beginner investors, it may seem like rocket science, but after you dip your feet in and learn the terms, you’ll see that it wasn’t as complicated as it appeared.
Investing is the number one path to lasting wealth, so don’t let jargon keep you from building a better life.