An unrealized loss is when an investor experiences a loss on a security but has not yet sold it. If the security’s value rises, the loss may be temporary, but if it continues to fall, the investor may want to sell to avoid further loss. Unrealized gains and losses only become realized when the security is sold.
Sometimes referred to as a paper loss, an unrealized loss is a situation where an investor has suffered a loss on a stock or other security, but has not yet officially assumed the loss. This unrealized loss may be a temporary situation, assuming the value of the security begins to rise once more and exceeds the price originally paid for the shares. If the investor chooses to sell the security while the price is still below the original purchase price, the unrealized loss is realized and can be claimed as a principal loss.
The easiest way to understand the nature of an unrealized loss is to consider buying a thousand shares of a given stock. Several weeks after that purchase, the value of those shares begins to plummet, due to some unanticipated event or change in the market. In a day or two, the value of those shares is half of what the investor initially paid. This means that the shareholder has experienced a fifty percent unrealized loss on the investment.
Depending on the circumstances surrounding the trend, the investor may project that the stock will soon level off and begin to rise in value once more. If that is the case, he or she may elect to hold the shares and eventually reduce the amount of unrealized loss as the value of the shares rises to a level that is more than the original purchase price. This would create what is known as an unrealized gain.
If the stocks do not recover and continue the downward trend, the investor will experience an increase in unrealized losses. Once it is clear that the stock is not going to recover, the investor would do well to sell the stock before the value declines further and thus avoid further increase in loss. Upon sale of the shares, the unrealized loss becomes a realized loss and can be claimed as a tax deduction for the period the loss is realized.
Both an unrealized loss and unrealized gain remain in that state until the investor decides to sell the security. At that point, the gain or loss is realized and the value of the investment portfolio is adjusted accordingly. This is important, as many tax agencies do not consider capital gains taxable until those gains are realized. Also, the loss generally cannot be claimed as a deduction until the amount is realized.
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