Understanding the way accounting and finance collide is always a good thing. So when you write to us and ask questions, we feel that it’s our duty to help you really understand what’s going on in the market. If you sit down with your bowl of cereal in the morning and watch the financial media, you might come across a large group of questions that are pretty hard to get answered — especially when you don’t know where to begin. While a lot of people argue that you can always pay someone to just stock pick for you, you want to make sure that you really understand the research process as much as possible. The best way to begin is definitely to look at a few terms that come up a lot.
For example, you might be concerned about the difference between realized and unrealized gains are. The reason why you want to keep your eye on this is because the IRS is actually going to be concerned about this. You see, an unrealized loss is when you have a stock that goes down in value after you purchase the shares. It’s considered something that happens quite often, because stacks rise and fall all the time. However, what you might want to know is that it’s really all about what happens at a sale or a purchase.
If you don’t sell the stock and it goes up in value, you have an unrealized gain. You can hold onto the stock and see if it will go up in value more or you can choose to sell it. It’s completely up to you. You really should make sure that you look at your overall investment plan to figure out what you should do. You might want to hold out a little longer, unless you really think that the stock has reached its peak.
Here’s the part that you have to keep in mind as well — it’s really all about the realized losses and gains, because those are what the IRS focuses on. Everything else is on paper — which is why some investors are quick to chide newcomers about getting too excited about unrealized gains. It’s not extra money in the bank until you actually sell the stock in question. However, the flip side is true — you shouldn’t be quick to react to every loss.
At the time of this writing, Google Inc. took a major tumble as their earnings and expenses combined weren’t up to street expectations. They went from about 575 down to 538 — that’s a massive loss, especially if you happened to have a lot of Google shares already. Now, does that loss become realized just automatically? No, it only becomes a realized loss — and a capital loss — when you go to sell it. In the case of Google, most people in this situation are going to hold onto their stocks and see if Google can rebound — if they can, and the stock rallies, then they’re in the clear — but again, it’s still an unrealized gain. They would have to sell the stock in order to gain the actual money for it.
In the eyes of the IRS, only the gains and losses that are realized — i.e., when the stock is sold — are the ones that truly matter. Everything else is just “on paper”. Realized gains are subject to capital gains tax, which depends on your tax bracket. Your brokerage will send you paperwork at the end of the year that will also be sent to the IRS — you must report that income, or you could face penalties. However, you still want to think about your losses and regroup if you really need to — that’s the real way to success!