An unrealized gain or loss is the difference between what an asset is worth now and its basis, measured while the holder still owns it. Basis starts at cost and moves with the adjustments recorded against it. No sale has happened and no cash has moved, so the figure is a measurement rather than a transaction, and it changes every time the asset is repriced. It becomes realized on a sale or other disposition of the property.
In securities accounting the change has its own name. A holding gain or loss is the net change in fair value of a security exclusive of dividend or interest income recognized but not yet received and exclusive of any write-downs for other-than-temporary impairment (FASB Statement No. 115, paragraph 137). Both carve-outs are already in earnings by another route, because dividend and interest income on an investment in securities continues to be included in earnings and the amount of an other-than-temporary write-down is included in earnings as a realized loss (FASB Statement No. 115, paragraphs 14 and 16).
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (FASB Statement No. 157, paragraph 5).
Calculating an Unrealized Gain or Loss
Basis is the starting point, and which basis depends on which set of books. For tax, the basis of property is the cost of that property (26 U.S.C. 1012(a)), and the adjusted basis for determining the gain or loss from the sale or other disposition of property is that basis adjusted as provided in section 1016 (26 U.S.C. 1011(a)). On the books the comparison for a security runs against its amortized cost basis, the figure Statement 115 has an enterprise disclose beside aggregate fair value and the gross unrealized holding gains and losses, for securities classified as available-for-sale and separately for those classified as held-to-maturity (FASB Statement No. 115, paragraph 19).
The arithmetic is one subtraction, current value less basis. A positive result is an unrealized gain, a negative result an unrealized loss, and the sign flips as often as the price does.
Cost basis of the position 30,000
Fair value at the reporting date 34,000
Unrealized gain 4,000
Fair value at a later reporting date 27,500
Unrealized loss against the same basis (2,500)Neither line is taxable income or a deduction, and the same position showed a gain at one date and a loss at another without a single transaction.
Unrealized Versus Realized
Unrealized means the holder still owns the asset, so the change sits in the measurement of what is held.
Realized means the measuring event has happened, a sale or other disposition of the property. The same subtraction runs once more with the amount actually received in place of the current value, and only that result enters an ordinary holder’s tax computation. Which events count, and the materiality threshold an exchange has to clear, are in disposition.
Where a Firm Meets the Number
For the positions a firm carries at fair value, the balance sheet amount is the current value rather than cost. Investments in debt securities not classified as held-to-maturity are measured at fair value in the statement of financial position (FASB Statement No. 115, paragraph 12), and equity securities with readily determinable fair values are measured at fair value with changes in the fair value recognized through net income (FASB Accounting Standards Update 2016-01).
Where the change gets reported depends on how the instrument is classified, and that split, with the year-end deemed-sale regimes on the tax side, is worked through in mark to market. Amounts kept out of earnings land in other comprehensive income, the section of comprehensive income that holds the gains and losses the standards keep outside the bottom line, and that boundary sits in net income.
An ordinary holder reports nothing until realization, which is why the books and the return diverge. A gain that ran through book earnings but is absent from the return is reconciled at line 7 of Schedule M-1, income recorded on books this year not included on this return (IRS, Form 1120). A gain parked in other comprehensive income never reaches that schedule at all, because line 1 starts from net income (loss) per books.
Common Questions
Generally not, for an ordinary holder. The tax computation runs off a sale or other disposition, so until the position leaves there is nothing received to measure against basis. The year-end deemed-sale regimes in mark to market are the exceptions rather than the rule.
It caps how much of a net capital loss can be deducted against other income in a year, and it reaches only losses that have been realized. For a taxpayer other than a corporation, losses from sales or exchanges of capital assets are allowed only to the extent of the gains from such sales or exchanges, plus, if the losses exceed the gains, the lower of $3,000 ($1,500 for a married individual filing a separate return) or the excess of the losses over the gains (26 U.S.C. 1211(b)). A net capital loss above the limit carries forward to later years (IRS, Topic no. 409). An unrealized loss never reaches this rule, because nothing has been sold.
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