Realized vs Unrealized Capital Gains

What are unrealized capital gains?

Unrealized capital gains are unreal: nothing has actually happened yet. You might be thinking of selling, you might have estimated how much profit there’ll be if you sell, but no transaction has taken place. Any gain (or loss) is still theoretical. 

For instance, let’s say last year you bought some stock for $1,000, and it’s now worth $2,000. You’ve doubled your money, right? Well, not so fast: so long as you still own the stock and haven’t sold it, that’s an unrealized capital gain. That $1,000 you’ve made is only an estimate.

What are realized capital gains?

Realized capital gains are real: you’ve sold your asset and you’ve made a profit. The same goes for a realized capital loss: you no longer own the asset and you lost money on the transaction. 

Let’s look at that stock you bought again. You bought it at $1,000 and now it’s worth $2,000. Great, time to sell! Once you’ve actually made that sale, the profit is no longer an estimate: it’s a fact. The $1,000 profit is a realized capital gain.

What is the difference between realized and unrealized capital gains?

The easiest way to remember the difference between realized and unrealized capital gains is the word real. In accounting terms, real means a transaction has taken place. While your portfolio is still (hopefully) growing and your profits are still an estimate, they’re unrealized capital gains. You can imagine spending your share of the proceeds, but there’s no actual money there. It’s only when you’ve sold and your capital gains are realized that the profits become real—and so does the tax bill.

When you own an investment like stocks, a house, or a cottage that’s going up in value, it’s easy to assume that you’ve made a certain amount of money, even if you aren’t planning to sell.

But while it’s a good idea to track the value of your investments, counting on those profits is like counting your chickens before they hatch. So long as you still own your investment, any gains are unrealized—the profits don’t actually exist. It’s only when you sell the investment that they become realized. 

Unrealized capital gains are just potential profit. Realized gains are cash in the bank.

What are some examples of realized and unrealized gains?

Let’s take stocks as an example. Say you own 100 shares in Smart Company Ltd. You paid $10 each for these shares a couple of years ago, and they’ve been going up in value.

You check the stocks app on your phone, and you see that Smart Company shares are now going for $20 each. Now you feel smart: your investments have doubled in value.

But wait: so far, these are unrealized capital gains. It might feel like you’ve made money, but the profits aren’t real until you sell the shares—they’re just an estimate. Tomorrow, the value might go up some more, or it might go back down. That estimate will change.

Once you do sell the shares, a transaction has occurred, you no longer own the asset and you can accurately count your profit. Those capital gains have become realized—hooray!—and you’ve got real money in your pockets. (Or, probably, your bank account.)

Do you have to pay taxes on unrealized capital gains?

In Canada, you don’t have to pay taxes on unrealized capital gains. Those gains are still theoretical: while you might count them as part of your net worth, no transaction has taken place, and you still own the asset.

Realized capital gains, however, are taxable, as a transaction has taken place.

How are unrealized gains accounted for?

If you own stocks, you will probably get a regular statement of their value, or you can log in to your account and see how much they’re worth. This is helpful for tracking your investments and net worth so you can make smart financial decisions. But they only matter in terms of planning: you don’t have to pay taxes on unrealized gains.

The same goes for houses and other property. You can estimate how much you might sell for and use that number for things like remortgaging and lines of credit, but until you sell, those capital gains are unrealized.

Do you pay taxes on capital gains that are reinvested?

As soon as your capital gains are realized—in other words, a transaction has taken place, usually a sale—they become taxable. Usually, you have to include them in the same tax year as the calendar year the transaction occurred. In other words, if you sell your cottage for a profit in 2023, that profit is a capital gain—it’s taxable, and must be included in your 2023 income tax return.

It doesn’t matter what you want to do with the capital gains (aka the money you earned). When you sell and earn a profit, you need to pay tax on that amount.

The exception is if you hold investments in a registered account like a TFSA or RRSP. Capital gains inside a TFSA are yours to keep—you never have to pay tax on them—and profits inside an RRSP are sheltered from tax until you withdraw the money, usually at retirement age. That’s one reason TFSAs and RRSPs are such valuable tools to save money: they’re tax shelters that prevent your capital gains from being taxed.

Can I avoid an unrealized capital gains tax?

Unrealized capital gains aren’t taxable in Canada. So long as your capital gains remain unrealized, you don’t have to pay taxes.

If you’re thinking of selling an asset and turning unrealized capital gains into realized (and taxable) capital gains, a little planning can help you lower the amount of tax you have to pay. For example, you might choose to sell in a year when your income (and, therefore, tax bracket) is lower.

Or, if you’re selling stocks, you could sell half in one year and half in another to split the capital gains between two tax years. (Of course, selling on different days means the value is unlikely to be exactly the same, but if you sell one half on December 31 and the other half on January 1, they’ll probably be pretty close.)