Are Unrealized Capital Gains Really Taxable? Avoid this Mistake + FAQs

No – under current U.S. law, unrealized gains are not taxable. You generally owe taxes only when a gain is realized (usually by selling the asset and locking in profit).

Confused about whether you owe taxes on unsold investment gains? You’re not alone…

American billionaires collectively held roughly $8.5 trillion in unrealized, untaxed gains as of recent estimates – highlighting how much wealth can grow without triggering a tax bill.

The tax rules around these paper profits can be confusing, but understanding them is crucial for investors big and small.

This in-depth guide will demystify unrealized gains and taxation, covering everything from the basic definitions to advanced tax proposals.

We’ll explore what current law says (and why), examine Biden Administration proposals and wealth tax debates, compare state policies, and walk through real-life examples for stocks, real estate, and crypto.

By the end, you’ll have a clear picture of how unrealized gains work and what potential changes could mean for your wallet.

In this guide, you’ll discover:

• 💡 Unrealized vs. realized gains – the difference and why unsold profits generally aren’t taxed (yet).

• 🏛️ Federal law on capital gains – why the IRS taxes you only when you cash out, and what “realization” really means.

• 🗺️ State-by-state breakdown – see if any state taxes paper gains (and which states are eyeing a wealth tax on the ultra-wealthy).

• 📈 Stocks, real estate, crypto examples – real scenarios showing when you do or don’t pay tax on growing investments.

• ⚖️ Pros & cons of taxing unrealized gains – why some call it a fair wealth tax and others warn it’s unworkable.

No Sale, No Tax: Understanding Unrealized vs. Realized Gains

Let’s start with the basics. Capital gains represent the increase in value of an asset above what you originally paid (your basis). When the value of your stock, property, or cryptocurrency goes up but you haven’t sold it, that increase is an unrealized gain – often called a “paper profit.” It’s money you would make if you sold the asset, but you’re still holding it.

In contrast, a realized gain happens when you sell or dispose of the asset for more than your basis. Only at that moment do you “lock in” the profit.

For example, if you bought shares for $1,000 and their value rose to $1,500, you have a $500 unrealized gain. If you sell those shares at $1,500, that $500 becomes a realized gain (and likely taxable income).

The distinction is crucial: unrealized gains exist only on paper – they reflect market value changes, but no cash has changed hands.

Realized gains, however, put actual profit in your pocket (or at least on your books). Tax law cares a lot about this difference, as we’ll see next.

Why the IRS Says “No Tax Until You Sell”

Under U.S. federal tax law, the guiding principle for investments is “no sale, no tax.”

The IRS does not tax gains until they are realized. In practical terms, if your stocks or property have appreciated but you haven’t sold, you generally do not list those gains as income on your tax return. The rationale is simple: you haven’t actually received any cash profit to pay tax with – your gain is still tied up in the asset.

This concept is known as the realization principle. It’s a long-standing rule in taxation that was affirmed by courts over a century ago.

Essentially, income for tax purposes is usually recognized only when there’s a “realization event,” like a sale or exchange. Without a sale, any gain is considered unrealized, and current law excludes it from taxable income.

Capital gains tax kicks in only when you sell an asset for a profit. At that point, the gain is typically subject to tax (at preferential long-term capital gains rates if you held the asset over a year, or at ordinary income rates for short-term holdings).

But until that sale occurs, your growing investment is on tax hold. This is why investors often say they’re deferring taxes by holding onto assets – because as long as they don’t sell, the IRS isn’t knocking.

It’s worth noting that this tax-deferral benefit can effectively serve as an interest-free loan from the government: you get to use the full value of your growing asset without paying tax until later (if ever).

Wealthy investors famously leverage this by holding assets, sometimes borrowing against their appreciated stock or real estate instead of selling, to avoid triggering taxes. They might even hold assets until death, at which point heirs can benefit from a step-up in basis (resetting the asset’s value for tax purposes, potentially erasing the unrealized gain from ever being taxed as income).

The Rare Exceptions: When Are Paper Gains Taxed?

Under typical circumstances, your paper gains remain untaxed until you sell. However, there are a few special cases where the tax code does tax unrealized gains (or effectively treats them as realized):

Mark-to-Market Rules for Traders and Certain Assets

In some situations, the IRS uses mark-to-market accounting, effectively pretending that a taxpayer sold and re-bought assets at year-end to compute gains. For example, certain financial traders (like professional commodities or securities traders who elect Section 475 mark-to-market status) must treat all their year-end holdings as if sold at market value.

Any resulting gains are counted as taxable income even though they didn’t actually sell those positions on December 31. This means their unrealized gains each year are treated as realized for tax purposes.

Similarly, specific financial instruments come with automatic mark-to-market taxation.

A prime example is futures contracts and some options under Section 1256 of the tax code. These are subject to an annual mark-to-market: at the end of each year, any gain or loss in open positions is considered realized (60% long-term, 40% short-term for futures) and taxed accordingly.

In essence, traders in these instruments pay tax on yearly paper gains by law, even if they continue holding the contract into the next year.

These cases are exceptions targeted at certain kinds of income or activities, aiming to prevent investors from deferring taxes indefinitely in fast-moving markets. Unless you’ve made specific tax elections or are dealing with these specialized assets, you won’t encounter mark-to-market taxation in your personal investments.

“Exit Tax” for Expatriation

Another rare scenario involves wealthy individuals who give up U.S. citizenship or long-term residency (expatriation). The U.S. imposes an “exit tax” on certain high-net-worth expatriates: essentially, it deems all their assets sold at the time of expatriation.

This means any unrealized gains on those assets become realized for tax purposes on the way out the door. It’s a one-time tax to prevent people from leaving the country just to avoid ever paying taxes on large accumulated gains.

While this affects very few people, it’s a case where unrealized gains can be taxed (because the law forces a fiction that you sold everything on your last day as a U.S. person).

Property Tax Increases (Indirect Tax on Unrealized Gain)

If you own real estate, you might be paying higher taxes each year even without selling. That’s because property taxes (levied by states and localities) are based on the assessed value of your property, which often rises as the market value rises.

When your home value jumps, your annual property tax bill can jump too – effectively taxing you on the increased value of the property (unrealized gain) even though you haven’t sold it.

It’s important to note that property tax isn’t a capital gains tax – it’s a wealth tax on the property’s value itself. But it’s one real-life way that appreciation can lead to higher taxes before any sale.

If your $200,000 house is now appraised at $300,000, you won’t owe federal capital gains tax until you sell, but you could see higher county property taxes due to that $100,000 gain on paper.

Aside from property taxes, most people won’t face taxes on unrealized gains under current law. But proposals to change this are brewing, especially for the ultra-rich.

Billionaire Tax Plans: Could Unrealized Gains Become Taxable?

In recent years, there’s been growing debate about whether extremely wealthy individuals should be taxed on their unrealized gains.

The idea stems from the fact that many billionaires accumulate massive wealth in assets like stocks without ever selling – meaning they can finance lavish lifestyles by borrowing against those assets and legally pay minimal income tax.

This strategy, often summarized as “Buy, Borrow, Die,” allows wealth to grow untaxed until death, when the step-up in basis can eliminate capital gains for heirs. To address this, lawmakers and the Biden Administration have floated proposals to tax unrealized gains of the richest Americans.

President Biden’s proposals: The Biden Administration has proposed a form of “billionaire minimum income tax.” One version of this plan would require households worth over $100 million to pay a minimum tax rate (e.g., 20%) on an expanded measure of income that includes unrealized gains.

In practical terms, very wealthy individuals would have to calculate the increase in value of their tradable assets each year and pay some tax on that appreciation, even if they didn’t sell. The goal is to ensure that billionaires pay at least a minimum percentage of their wealth growth in taxes annually, closing what some view as a loophole that lets wealth go untaxed for decades.

Wealth tax proposals: Beyond Biden’s specific plan, several lawmakers (like Senators Elizabeth Warren and Bernie Sanders) have championed a more straightforward wealth tax.

A wealth tax would impose an annual tax on net worth above a certain threshold (for example, 1% yearly on wealth over $50 million, and 2-3% on even higher fortunes). This is slightly different from a capital gains tax: it wouldn’t matter if the wealth came from unrealized gains or cash – it’s essentially taxing the pile of assets directly each year.

Wealth tax proposals also effectively target unrealized gains, since a large portion of an ultra-rich person’s wealth is often in the form of unsold stocks, real estate, or business ownership that has appreciated.

Mark-to-market for billionaires: Another approach that’s been discussed in Congress (notably by Senator Ron Wyden) is a comprehensive mark-to-market tax system for ultra-wealthy individuals.

Under such a system, billionaires might be required to report and pay tax on their gains each year just like the Section 1256 futures rule, but applied to a much broader range of assets. This raises complex questions about how to value illiquid assets (like private businesses or artwork) annually.

So far, none of these federal proposals have become law. They tend to face political opposition and practical challenges. For example, if a billionaire’s fortune is tied up in a company they founded, forcing them to pay tax on paper gains could compel them to sell stock or find cash each year, which might disrupt the business or market. There’s also the risk that asset values could decline after being taxed on prior gains (raising the question of refunds or loss offsets).

It’s important to note: average investors are not the target of these proposals. The discussions at the federal level have centered on extremely wealthy households (multi-millionaires and billionaires).

So if you’re an everyday investor, the prospect of the IRS taxing your yearly portfolio growth is not on the immediate horizon. Still, these high-profile debates show a possible future shift in how we think about income and taxation, which could trickle down in unforeseen ways.

On the flip side, some proposed reforms would only tax unrealized gains at certain events – for instance, at death or upon gift transfer, to prevent gains from escaping tax forever via step-up. President Biden at one point suggested taxing capital gains at death above a large exemption (effectively treating death as a sale for tax purposes on big unrealized gains). Such measures also haven’t passed as of now, but they illustrate the range of ideas being considered.

State-by-State Breakdown: Does Any State Tax Unrealized Gains?

At the state level, no U.S. state currently taxes unrealized capital gains as part of its income tax system. States, like the federal government, generally tax capital gains only when they are realized through a sale or exchange. However, that’s not the end of the story – some states have been exploring wealth taxes or similar concepts, and all states have their own mix of taxes that can indirectly tap into asset values (like property taxes).

Below is a breakdown of how different states treat unrealized gains and related wealth taxes:

As the table shows, no state currently taxes unrealized capital gains as income. The vast majority simply follow the federal approach: they tax capital gains only upon realization, often treating gains as ordinary income (though a few states offer partial breaks for certain long-term gains). A number of states don’t tax income at all – meaning they have no tax on capital gains even when you do sell.

That said, several states (like California, New York, Illinois, Washington, and others) have seriously considered wealth taxes or mark-to-market taxes targeting ultra-wealthy residents. These proposals have varied: some aimed to tax a percentage of a rich individual’s net worth each year, while others sought to annually tax unrealized gains above a very high threshold. None of these have become law to date, partly due to legal complexities and fears of capital flight. But the fact they’re being discussed in statehouses shows a keen interest in tapping unrealized wealth at the state level.

Also, remember that all states (and local governments) do indirectly tax some forms of wealth via property taxes. If your property’s value has risen, your local tax assessor may charge you higher property taxes, capturing some of that unrealized appreciation. A few states historically taxed intangible personal property (like stocks or bonds) with an annual levy, but nearly all such taxes have been repealed (Florida’s repeal in 2007 is one example).

For now, if you’re worried about a surprise state tax on your unsold stocks or crypto gains, you can breathe easy – none of the 50 states will send you a bill for simply watching your portfolio value rise.

Stocks, Real Estate, Crypto: Examples of Unrealized Gains in Action

It’s helpful to see how unrealized gains work across different types of assets. Let’s walk through three common scenarios – stocks, real estate, and cryptocurrency – to illustrate when taxes do or don’t come into play:

As you can see, in each case there’s a significant gain on paper, but no immediate income tax liability because the asset hasn’t been sold. Let’s delve a bit deeper into each scenario:

Stocks Example: No Tax Until You Sell 📈

Imagine you bought 100 shares of a tech company at $100 each, for a total investment of $10,000. Over the next year, the stock’s price shoots up to $150 per share. Your 100 shares are now worth $15,000 – a nice $5,000 unrealized gain. Come tax time, do you owe anything on that $5,000 increase? No. Since you didn’t sell the shares, the IRS doesn’t consider that $5,000 as taxable income for the year.

Now, if you decide to sell some or all of those shares and lock in the profit, that’s when you’ve realized the gain and a tax is triggered. Say you sold all 100 shares at $150 – you’d realize a $5,000 gain and likely owe capital gains tax on that amount (the exact tax would depend on whether it’s a short-term or long-term gain and your tax bracket). But until the sale happens, that growth is tax-deferred.

A useful thing to note: if the stock price later falls back to $100 (or below) and you never sold at $150, you avoided paying tax on a gain that vanished. This highlights one reason the tax code waits for realization – if they taxed you at $150 and then the stock crashed, you paid tax on wealth you no longer have. By taxing only after a sale, the system typically taxes you on gains you actually pocketed.

Real Estate Example: Home Values Up, But No Capital Gains Tax 🏠

Suppose you bought a house a few years ago for $300,000. The neighborhood has become very popular, and now your home’s market value is $400,000. On paper, you’ve got a $100,000 gain in your property’s value. Do you owe federal tax on that increase? No, not until you sell the house. U.S. tax law doesn’t impose capital gains tax on an increase in your home’s value while you continue to own it.

However, as mentioned earlier, you might feel a tax impact through your property taxes. Your county assessor may raise your home’s assessed value toward $400,000, which could increase your annual property tax bill. That’s an indirect way you’re paying for that unrealized gain, but it’s not a capital gains tax and it goes to local government, not the IRS.

Now, if you eventually sell the home, the tax situation gets interesting. When you sell a primary residence, you may qualify to exclude a large portion of the gain from taxes (up to $250,000 for single filers or $500,000 for married filing jointly, under current IRS rules) if you lived in the home for at least two out of the last five years. So in our example, if you sold at $400,000, that $100,000 gain might be fully tax-free under those homeowner exclusions. If the gain were larger (say you sold for $700,000, a $400,000 gain), you might pay capital gains tax on the portion above the exclusion. But again, none of this matters until you actually sell. If you never sell and perhaps pass the home to your children, current law would give them a step-up in basis to the home’s market value at your death, potentially erasing the income tax on that gain entirely.

Cryptocurrency Example: Volatile Gains and No Tax Until Trade 🚀

Consider an investor who bought 2 Bitcoins for $10,000 each, a total of $20,000. A year later, the crypto market booms and Bitcoin’s price goes to $30,000. Those 2 BTC are now worth $60,000 – an unrealized gain of $40,000. Despite the big increase, no tax is due just for holding the cryptocurrency. The IRS views crypto like property: you’re only taxed when you sell, trade, or otherwise dispose of it.

This means if you simply hold your crypto in your wallet while its value swings up (or down), you don’t report anything on your taxes for those fluctuations. But if you decide to trade 1 BTC for cash or even for another cryptocurrency, that act is a taxable event. For instance, exchanging 1 BTC (worth $30K now) for Ethereum or for dollars is treated as if you sold that 1 BTC, realizing a $20K gain, which would be taxable.

One tricky aspect with crypto is that people sometimes swap one coin for another or even use crypto to buy an NFT or other asset – and each of those swaps is a realization event in the eyes of the IRS. But if you’re just watching your Bitcoin or NFT collection skyrocket in value and not taking any action, you won’t owe tax on that rise at the end of the year.

It’s also worth illustrating the flip side: crypto is notoriously volatile. Suppose your 2 BTC went up to $60K in Year 1 (no tax as you held), but by Year 2, the price fell back to $15K each (total $30K value). If you never sold, you never paid tax on the run-up, and now the gain has evaporated. Had there been an unrealized gains tax annually, you might have paid tax on phantom income in Year 1 and then seen your asset’s value drop, which would feel very unfair. Instead, under current rules, you ride the wave without tax until you decide to cash out (if ever).

These examples across stocks, real estate, and crypto all reinforce the same point: unrealized gains aren’t taxed as long as you keep the asset. Each asset class has its own additional wrinkles (homeowner exclusions, crypto trading rules, etc.), but the core principle holds.

The Debate: Pros and Cons of Taxing Unrealized Gains

The idea of taxing unrealized gains is controversial and sparks lively debate among economists, policymakers, and investors. Let’s break down some key arguments on both sides:

As shown above, there are strong views on either side. Proponents see it as a way to modernize the tax system to match how wealth is accumulated in the real world, ensuring the very rich pay their share yearly just like workers do. Opponents worry it would be impractical, potentially harmful to the economy, and possibly illegal without constitutional changes.

It’s also possible to find middle-ground ideas: for example, only taxing unrealized gains at certain milestones (like at death or above a very high threshold), or offering deferral with interest charges (so if you defer tax on gains, you pay interest on the deferred tax, as is done in some international tax situations). These nuances show that even if the principle of taxing paper gains were adopted, the implementation could take many forms.

For now, the status quo remains that unrealized gains are not taxed. But this debate isn’t going away, especially as wealth concentrates in assets and public attention stays on whether the richest Americans pay enough tax. It’s a space to watch for future developments.

Bottom Line

Under current law, unrealized gains are not taxable – you won’t pay taxes on investment growth until you actually realize the gain. For everyday investors, this means you can watch your portfolio rise without an immediate tax hit. However, high-net-worth individuals are facing increasing scrutiny, and future tax reforms (at federal or state levels) could chip away at the realization principle for the ultra-wealthy.

Staying informed is key. Tax rules can change, and proposals to tax wealth or unrealized gains might evolve. But as of now, remember: if you haven’t sold, you generally haven’t earned income in the eyes of the taxman. Enjoy the ride up 📈, and plan for taxes only when you decide to cash in.

FAQ: Unrealized Gains Tax Questions, Answered

Q: Do I have to pay taxes if my stocks went up but I didn’t sell?
A: No. If you haven’t sold your stocks, any increase in value is not taxed. You only pay capital gains tax after you sell shares for a profit.

Q: If my crypto increased in value, do I owe tax before cashing out?
A: No. Cryptocurrency gains aren’t taxed until you sell, trade, or otherwise dispose of the coins. Simply holding crypto as it rises in value does not trigger a tax.

Q: Can I avoid capital gains tax by never selling my investments?
A: Yes. If you never sell an asset, you never realize the gain and thus owe no capital gains tax on it. (Large estates could still face estate taxes, and laws could change.)

Q: Do I report unrealized gains on my tax return?
A: No. You do not report unrealized gains to the IRS. Only realized gains (from sales or dispositions that actually occurred) need to be reported as income on your tax return.

Q: Do any U.S. states tax unrealized gains?
A: No. As of now, no state taxes unrealized gains as income. States only tax gains when realized (though all states use property taxes, which can rise as property values increase).

Q: Is there a new law that taxes unrealized gains for wealthy people?
A: Not yet. Proposals have been made to tax billionaires’ unrealized gains, but no such law has been enacted at the federal level as of now.

Q: Are property taxes basically a tax on unrealized gains?
A: Yes, in a sense. Property taxes increase as your property’s value (and unrealized appreciation) increases. It’s not called a capital gains tax, but it does tax you on rising asset value annually.

Q: Can I deduct losses if my investments dropped but I didn’t sell?
A: No. Unrealized losses are not deductible. You can only claim a capital loss for tax purposes after you sell an asset for less than you paid, thereby realizing the loss.