"Realized" gains and losses are those that result from your selling an investment, as opposed to continuing to hold it. You pay taxes only on realized -- not unrealized -- gains, and you take a tax write-off only for realized losses. The amount of your realized gains and losses in any given tax year helps drive certain other investment decisions.
Unrealized to Realized
Suppose you purchased some shares of stock at $10 and the share price has risen to $25. You have a nice gain. As long as you continue to own the shares in your brokerage account -- that is, you have not sold them -- that gain is "unrealized." The shares might move higher, increasing your gain, or they might lose value, decreasing the unrealized gain. Once you decide to sell the shares, you are said to "realize" the gain or loss. Any capital gain or loss becomes realized when you sell an investment.
A gain or loss on an investment is not reportable for tax purposes until that gain has been realized. If you own a stock for years and do not sell, you will not pay taxes on the gains even if the stock goes up 1,000 percent or more. When you sell the stock, you will be liable for taxes on the gain. On the down side, you cannot use an investment loss as a tax write-off unless you have sold the investment and realized the loss.
Capital Gains and Losses
Realized gains and losses are known as "capital" gains and losses when it's time to do your taxes. The gains and losses are the result of the sale of a capital asset -- tax jargon for anything you own. Taxes must be paid on any capital asset you sell for a gain. However, capital losses qualify as tax deductions only if the capital asset was held as an investment. For example, you cannot sell your sofa at a loss and take a write-off for the realized loss.
Timing Your Investment Sales
The fact that an investment gain or loss is not a taxable event until the gain or loss is realized allows you to time your sales and manage the taxes paid on your investment gains. For example, if you own an investment for more than one year before realizing the gain, the gain will be categorized as a long-term capital gain and taxed at a lower rate than for short-term capital gains. Also, capital losses often are best used to offset capital gains. So in a year when you have some big gains, it might be time to sell a few of your losers to cut your tax bill.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.