Key Takeaways
- Unrealized gains occur when the value of your crypto increases but remains unsold. Unrealized losses represent a decline in value without selling. These changes exist only on paper.
- Taxes apply only to realized gains, meaning you pay when you sell crypto for fiat. Unrealized gains are generally not taxable until converted into actual profit.
- Subtract your purchase price from the current market value to determine unrealized gains or losses. This helps assess your portfolio’s potential value before selling.
- Realized profits trigger tax obligations, while realized losses may reduce taxable income. Keeping records helps with tax planning and ensures compliance with regulations.
Even as crypto thrives with over $2 trillion in market value, its operation remains distinct from traditional currency. As tax season approaches, many crypto enthusiasts face the challenge of knowing which parts of their portfolio require reporting.
In this article, we break down two essential terms for your crypto tax filing: unrealized gains and losses.
What Are Unrealized Gains and Losses in Crypto?
At first glance, crypto might seem unpredictable, but when you learn to read its signals, the picture gets clearer. Unrealized gains refer to profits that exist on paper. These gains appear when the value of your investment increases, yet you have not yet converted your digital assets back to fiat. You experience crypto gains only on paper.
Likewise, unrealized losses represent the decline in your investments that you have not cashed out. They remain abstract until you decide to take action. Essentially, the difference between assets held in crypto and assets exchanged for cash helps form your overall picture of crypto profits.
How Unrealized Gains Work
Crypto portfolios often contain investments that show profit or loss without being exchanged for traditional money. Let’s break down how unrealized gains work.
Realized vs unrealized gains
Realized vs unrealized gains is a critical concept. You generate a realized profit when you sell an asset and receive fiat. Your investment journey changes from potential profit to actual profit that you can use.
Conversely, if your digital assets are still held in your wallet, any profit remains unrealized. You enjoy an unrealized profit on paper without capturing the crypto gains until you choose to sell. This distinction matters when you consider your tax filing. Taxes typically apply to realized amounts, not the potential in your digital wallet.
Example of an Unrealized Gain
Consider the story of Alex, a crypto whale with a growing portfolio. Alex buys Bitcoin, Litecoin, and Ethereum when their prices are low. Over time, the tokens have been appreciated, and Alex’s portfolio has shown a noticeable increase. As the price climbs, Alex enjoys an unrealized profit. On paper, Alex’s investment demonstrates that the crypto gains are appealing. However, the gains remain unrealized because Alex has not converted the tokens into fiat.
Fast forward to tax season. Alex reviews the portfolio, noting both crypto profits and the potential taxes associated with converting assets. The distinction between realized and unrealized gains becomes evident. When Alex sells some tokens and locks in the profits, those gains become taxable income. Until then, the increases remain in the “what are unrealized gains” category—a vivid example of the difference between holding digital assets and cashing out.
How Unrealized Losses Work
What happens when the market takes a downturn? Let’s explore the concept of unrealized losses.
Realized vs Unrealized Losses
The phrase realized vs unrealized losses describes the same principle as gains, but in reverse. When your crypto investment’s value drops, you might see a loss on paper. This represents a reduction in the potential value of your portfolio.
However, if you choose not to sell, the loss remains unrealized. The loss is like a silent reminder that while the market may seem unfavorable, the change only becomes real when you exit the position. In this scenario, the financial impact does not occur until the loss is turned into a realized event by selling the asset at a lower price than you paid..
Example of an Unrealized Loss
Now consider Jamie, who invested in a promising memecoin during a high period, and has self-custody of the crypto. When the market turns, the token’s value falls. Jamie’s wallet now shows an unrealized loss, a decline in crypto profits that is visible but not yet materialized as an actual deficit. Jamie waits, hopeful for a market recovery, and the loss stays on paper.
Come tax time, Jamie must review the details carefully. The difference between holding and selling the tokens becomes significant in calculating the taxable events. When Jamie eventually sells, the unrealized losses may help lower the overall taxable income if they offset realized gains. Until then, these losses remain as numbers that have not yet been crystallized into a final figure.
How to Calculate Unrealized Gains and Losses
Start by looking at each asset’s current market price and comparing it to the original purchase price.
Unrealized Gain/Loss = Current Market Value – Original Purchase Price
This simple calculation allows you to determine the current paper profit or loss on any cryptocurrency you hold by subtracting the price you initially paid from its current market value.
How are Unrealized Gains Taxed?
Tax regulations vary across regions, and the treatment of unrealized gains in crypto is no exception. In many cases, tax authorities require reporting only on gains that have been realized. This means you pay taxes only when you sell your crypto and convert it to fiat currency, turning potential gains into actual profit.
Some jurisdictions do not tax unrealized gains until you decide to make them real. Understanding these distinctions is important for keeping your tax return compliant and avoiding surprises.
Why Gains/Losses Are Important for Taxes
The terms crypto gains and crypto profits might seem to exist solely on paper until you decide to convert your assets. Tax authorities care about realized profit. When you file your return, taxes apply to the profit made from actually selling your investments.
On the flip side, losses that become realized might qualify as deductions. This understanding shapes how you manage your portfolio during tax season and guides your decision on when to sell or hold. Staying informed about your financial performance helps you plan better for tax filings and comply with local regulations.
Do Unrealized Gains/Losses Have to Be Reported?
The reporting requirements for unrealized gains and losses depend on where you live. In some areas, only realized gains appear on your tax return, while other jurisdictions might have different rules for digital assets.
Often, regulations state that you must report crypto profits when they become actualized by converting them to fiat. Since crypto is a unique category compared to traditional investments, familiarizing yourself with local tax guidelines is wise. Checking with a tax professional can provide clarity tailored to your situation.
Closing Thoughts
In essence, unrealized gains and unrealized losses are simply the changes in the value of your cryptocurrency investments that haven’t been finalized by a sale. While potentially exciting to see your portfolio grow, these crypto gains and profits don’t trigger immediate tax obligations. You need to be mindful of the realized gains – the profits you lock in when you sell – for tax purposes.
Similarly, unrealized losses represent a decrease in value that hasn’t yet resulted in an actual financial loss. By understanding the distinction between realized vs unrealized gains and realized vs unrealized losses, and by keeping track of both, you can make more informed decisions about your digital assets.
