What Are Unrealized Capital Gains and How Are They Taxed?
Learn the key distinction between a potential profit on assets you own and a taxable gain, and see how the timing of a sale or transfer impacts what you owe.
An unrealized capital gain is the increase in an asset’s value before it has been sold. For instance, if you purchase a home and its market value increases over several years, you have an unrealized gain. This “paper profit” is the difference between what you paid and the asset’s current worth.
This concept applies to assets like stocks, bonds, and real estate. The value can fluctuate with the market, meaning the unrealized gain can grow or shrink. Under U.S. tax law, this increase in value is not a taxable event until the asset is sold.
Calculating an Unrealized Capital Gain
To calculate an unrealized capital gain, you first need the asset’s cost basis. The cost basis is your total investment for tax purposes, which includes the original price plus associated costs like brokerage fees and commissions.
For real estate, the cost basis starts with the purchase price and adds closing costs, such as legal fees and title insurance. The basis is increased by the cost of capital improvements, like a new roof, and reduced by factors like depreciation claimed on a rental property. You are responsible for tracking this adjusted basis.
The formula is: Current Market Value – Adjusted Cost Basis = Unrealized Capital Gain. For example, if you bought 100 shares of stock at $50 per share with a $10 commission, your cost basis is $5,010. If the stock’s price rises to $80 per share, the market value is $8,000, resulting in an unrealized gain of $2,990.
Similarly, if you buy a property for $300,000 with $5,000 in closing costs, your initial basis is $305,000. Spending $40,000 on an addition raises your adjusted cost basis to $345,000. If the property’s current market value is now $500,000, your unrealized capital gain is $155,000.
From Unrealized to Realized The Taxable Event
An unrealized gain becomes a realized gain when you sell or dispose of the asset, which triggers a tax liability. This converts the “paper profit” into actual profit that must be reported to the IRS. Brokerage firms report sales of securities on Form 1099-B.
The tax treatment of a realized gain depends on the holding period—the length of time you owned the asset. This duration determines if the gain is short-term or long-term, each with different tax implications.
A short-term capital gain results from selling an asset held for one year or less. These gains are taxed at ordinary income tax rates, which for 2025 range from 10% to 37%, depending on your filing status. The gain is added to your other income, such as wages, and taxed accordingly.
A long-term capital gain occurs when you sell an asset held for more than one year. These gains are taxed at lower rates of 0%, 15%, or 20% for 2025, based on your income level. For example, a single filer with a taxable income of up to $48,350 in 2025 would pay a 0% rate on long-term gains.
Special Tax Rules for Unrealized Gains
Special tax rules apply when an asset is inherited or gifted. The most significant of these is the “step-up in basis” that occurs when an individual inherits an asset. This provision, from Internal Revenue Code Section 1014, adjusts the heir’s cost basis to the asset’s fair market value on the original owner’s date of death.
This adjustment means the unrealized capital gains accumulated during the decedent’s lifetime are not subject to income tax. For example, if a parent bought stock for $10,000 that was worth $150,000 on their date of death, the inheriting child receives a new cost basis of $150,000. Selling the stock immediately for that price results in no taxable gain.
When gifting an asset with an unrealized gain, the rules are different. The recipient does not get a stepped-up basis; instead, they receive the donor’s original cost basis. This principle is known as “carryover basis,” meaning the potential tax liability is transferred to the recipient.
If a person gifts stock they bought for $2,000 that is now worth $10,000, the recipient’s cost basis is $2,000. Should the recipient later sell the stock for $11,000, they will be responsible for the tax on the $9,000 realized gain. This rule prevents individuals from avoiding capital gains tax by transferring assets to others before a sale.