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Are unrealized gains taxable?

Maximizing tax efficiency: Smart moves for savvy investors
Bogdan Stojkov

Unrealized gains often puzzle taxpayers, leaving them wondering whether they owe taxes on these gains. To navigate this complex terrain, it’s crucial to grasp the concept of unrealized gains, how they differ from realized gains, and whether they trigger tax liabilities. As such, let’s delve into these aspects to demystify the taxation of unrealized gains.

What are unrealized gains?

Unrealized gains represent the increase in the value of an asset that an investor holds but has not yet sold. In simpler terms—it’s the profit on an investment that exists on paper but hasn’t been converted to cash through a sale. These gains remain hypothetical until the asset is sold, at which point they become realized gains.

Common examples of assets that can generate unrealized gains include:

Realized vs. unrealized gains

To grasp the concept better, it’s best to differentiate between realized vs. unrealized gains:

  • Realized gains: These gains occur when an investor sells an asset for a price higher than the purchase price. Once the sale is executed, the profit becomes realized and is subject to taxation, depending on various factors such as the holding period and the investor’s tax bracket;
  • Unrealized gains: On the other hand, unrealized gains occur when the value of an asset increases, but the investor hasn’t sold it yet. Since no actual sale has taken place, these gains are not yet taxable by the government. They only become taxable upon realization, i.e., when the asset is sold.

Tax on unrealized gains

The tax on unrealized gains varies depending on the type of asset and the tax jurisdiction. In general, most countries do not tax unrealized gains. Instead, taxes are levied on realized gains when the asset is sold. However, there are exceptions to this rule, especially for certain types of assets or specific situations.

What countries tax unrealized?

While the general principle is that unrealized gains are not taxed until they are realized, some countries have specific provisions that may impose an unrealized gains tax. Therefore, let’s take a look at the taxation of unrealized gains in some countries:

Country Taxation of unrealized gains
United States Generally not taxed, with exceptions for certain assets like retirement accounts
Canada Generally not taxed, with reporting requirements for foreign property
United Kingdom Generally not taxed, with exceptions for certain assets like residential property
Germany Taxes unrealized gains on certain assets, such as shares, if specific criteria are met
Table 1: Taxation of unrealized gains in different countries

1. United States

In the U.S., unrealized gains are typically not subject to taxation. However, there are exceptions for certain types of assets, such as retirement accounts like 401(k)s and IRAs. In these accounts, investment gains are tax-deferred, meaning they are not taxed until withdrawals are made during retirement.

2. Canada

Similar to the U.S., Canada generally does not tax unrealized gains. However, Canadian residents with foreign property exceeding $100,000 CAD are required to report these assets annually on their tax returns.

3. United Kingdom

In the UK, there is no specific tax on unrealized gains. Instead, taxes are imposed when gains are realized, such as through the sale of assets. However, there are exceptions for certain assets like residential property held by non-residents.

4. Germany

Germany taxes unrealized gains on certain assets, such as shares, if the investor owns more than 1% of the company’s shares. This tax is known as the wealth tax or net wealth tax and is levied annually.

Taxation of unrealized gains on cryptocurrencies

Cryptocurrencies have introduced unique challenges in terms of taxation, including the treatment of unrealized gains. In many jurisdictions, the taxation of cryptocurrency gains is still evolving, and regulations vary widely.

However, some countries have provided guidance on the taxation of unrealized gains on cryptocurrencies:

  • United States: The Internal Revenue Service (IRS) treats cryptocurrencies as property for tax purposes. This means that unrealized gains on cryptocurrencies are generally not taxed until they are sold or exchanged for fiat currency or other assets. Nevertheless, cryptocurrency transactions may trigger tax reporting requirements, such as the filing of Form 8949 for capital gains and losses.

Is Biden trying to tax unrealized capital gains?

President Joe Biden’s fiscal year 2025 tax proposal includes a new measure targeting unrealized gains, specifically levying a 25% tax on these gains for high-net-worth individuals with net assets exceeding $100 million. This initiative is part of broader efforts to ensure that wealthier individuals contribute a fairer share to tax revenues, aligning the tax contributions of high earners from both ordinary and investment income more closely.

Tax strategies for unrealized gains

While unrealized gains are not subject to taxation until they are realized, investors can employ certain strategies to manage their tax liabilities effectively. Here are some strategies to consider:

  • Tax-loss harvesting: This strategy involves selling investments that have experienced losses to offset capital gains and reduce tax liabilities. By realizing losses, investors can use them to offset realized gains, thereby minimizing their overall tax burden;
  • Tax-advantaged accounts: Investing in tax-advantaged accounts such as IRAs and 401(k)s can help defer taxes on investment gains. Contributions to these accounts are often tax-deductible, and investment gains grow tax-deferred until withdrawals are made during retirement;
  • Estate planning: Unrealized gains on assets held until death may receive a step-up in basis, which can reduce or eliminate capital gains taxes for heirs. Estate planning strategies such as trusts and gifts can help minimize taxes on unrealized gains passed on to beneficiaries.

The bottom line

To summarize, unrealized gains represent the increase in the value of an asset that has not yet been sold. While unrealized gains are not typically subject to taxation, there are exceptions depending on the type of asset and the tax jurisdiction. Hence, understanding the taxation of unrealized gains is essential for investors to effectively manage their tax liabilities and maximize their after-tax returns.

Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

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