An unrealized loss is the decline in value of an investment you still own. If you paid $5,000 for a stock that’s now worth $4,000, that $1,000 gap is an unrealized loss, sometimes called a paper loss because nothing has been locked in. It only becomes real when you sell, and until then it doesn’t touch your tax return, though it can still shape your financial picture in ways worth understanding.
How to Calculate It
The math is simple: subtract the current market value from your cost basis. Cost basis is what you originally paid, including commissions and transaction fees. Market value below basis is an unrealized loss. Market value above basis is an unrealized gain.
Buy 100 shares at $50 for a total of $5,000. The stock drops to $40, so your holdings are worth $4,000. Unrealized loss: $1,000. If the stock instead climbs to $65, your holdings are worth $6,500 and you’re sitting on a $1,500 unrealized gain. Nothing changes on your tax return in either case.
This works the same way for almost any asset with a fluctuating market price: stocks, bonds, mutual funds, real estate, commodities, and cryptocurrency. The loss stays unrealized as long as you hold the position.
When the Loss Becomes Real
Selling is the usual trigger. The moment your sell order executes and settles, the loss is final and reportable. Sell those 100 shares at $40 and the $1,000 loss is realized. Hold on and watch the price recover to $55, and the unrealized loss vanishes into a $500 unrealized gain instead.
That difference matters. An unrealized loss reduces your net worth on paper without touching your cash. A realized loss is permanent and immediately reduces both.
You don’t always get to choose the timing. The IRS treats certain involuntary events as realization triggers. If property is destroyed, stolen, or condemned by a government authority, the resulting gain or loss is generally recognized in the year it happens.1Internal Revenue Service. Involuntary Conversions: Real Estate Tax Tips Foreclosures work similarly. In these cases you may owe tax or be entitled to a deduction even though you didn’t voluntarily sell anything.
Why You Can’t Deduct It Yet
The IRS doesn’t care about unrealized losses. You can’t deduct them and they don’t reduce your tax bill. The tax code only recognizes a capital loss when you dispose of the asset. Once you sell, you report the transaction on Form 8949 and carry the totals to Schedule D.2Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets
That rule cuts two ways. A sinking portfolio gives you no tax relief while you hold. But you also control the timing of when losses become deductible, and that control is the foundation of tax-loss harvesting.
Turning Losses Into Tax Savings
Tax-loss harvesting is the deliberate sale of an investment at a loss to generate a realized capital loss you can use on your return. That realized loss offsets realized capital gains dollar for dollar. If your total realized losses exceed your total realized gains for the year, you can deduct up to $3,000 of the excess against ordinary income, or $1,500 if you’re married filing separately.3Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
Anything above that $3,000 annual cap carries forward to future tax years indefinitely.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses Realize a $20,000 net capital loss with no gains to offset, and you’d deduct $3,000 this year and carry $17,000 forward. You can keep chipping away at that balance $3,000 a year, or spend it all at once against a large capital gain in a future year.
The Wash Sale Trap
There’s a catch. The IRS won’t let you sell an investment at a loss and immediately buy it back just to claim the deduction. Under the wash sale rule, a realized loss is disallowed if you acquire the same security, or one that’s “substantially identical,” within 30 days before or 30 days after the sale. Counting the sale date itself, that’s a 61-day window to stay clear of.5Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
The rule catches more than obvious repurchases. Buying a call option on the same stock, or acquiring it in a different account such as a spouse’s IRA, can trigger it. “Substantially identical” has no bright-line test; the IRS looks at facts and circumstances. Stocks of two different companies in the same industry are generally not considered substantially identical, and shares of one mutual fund are ordinarily not identical to shares of another even if they track similar indexes.
A disallowed loss isn’t gone forever. It gets added to the cost basis of the replacement shares, which pushes the tax benefit forward until you sell those new shares in a clean transaction.
Cryptocurrency Sits Outside the Rule
The wash sale statute applies only to “stock or securities.” Cryptocurrency is currently classified as property for federal tax purposes, not as a security, so you can sell a crypto position at a loss and immediately repurchase the same coin without triggering a wash sale disallowance.5Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities Tax law around digital assets is evolving quickly, and legislation could close this gap.
When an Investment Becomes Worthless
Sometimes an investment doesn’t just drop; it goes to zero. A company files for bankruptcy, the stock is delisted, and the shares in your account sit at $0.00 with no buyer. You haven’t sold anything, so how do you claim the loss?
The tax code treats worthless securities as if they were sold on the last day of the tax year in which they became worthless.6eCFR. 26 CFR 1.165-5 – Worthless Securities You can also formally abandon a security by permanently surrendering all rights in it and receiving nothing in return.7Internal Revenue Service. Losses (Homes, Stocks, Other Property) Either way, you report the loss on Form 8949 like any other capital loss.
Proving worthlessness is the hard part. You need to show the security has no liquidating value and no realistic prospect of future value. A bankruptcy filing, a shutdown of operations, or a sale of substantially all assets typically supports the case. If there’s any argument the company might recover, the IRS can challenge the deduction. Holding period still counts: more than a year makes the loss long-term, a year or less makes it short-term.
Losses That Disappear at Death
This one catches families off guard. When you die, your heirs inherit your assets at fair market value on the date of death. The step-up in basis for appreciated assets is well known. The step-down is not: if an asset has lost value, the heir’s basis is reset to the lower market price.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Say you bought stock for $50,000 and it’s worth $30,000 when you pass away. Your heir inherits it with a $30,000 basis. That $20,000 unrealized loss vanishes. Nobody deducts it. Had you sold before death, you could have harvested the $20,000 loss against other gains or against ordinary income. Once the asset passes through your estate, that opportunity is gone.
For someone with significant unrealized losses and a terminal diagnosis or advanced age, selling depreciated assets before death to capture those losses is worth serious consideration. The step-down rule does not apply to inherited retirement accounts like IRAs and 401(k)s, which follow different distribution rules.
When a Paper Loss Forces Real Action
Unrealized losses are supposed to be theoretical. In a margin account they aren’t. When you buy securities on margin, your broker lends you part of the purchase price. FINRA requires equity of at least 25% of the current market value of your holdings, and many brokers set the bar higher, at 30% or 40%.9FINRA. FINRA Rule 4210 – Margin Requirements
As unrealized losses pile up, your account equity shrinks. Drop below the maintenance threshold and your broker issues a margin call, demanding cash or additional securities. Fail to meet the call promptly and the broker can liquidate your positions without your consent, turning unrealized losses into realized ones at the worst possible moment.
The Mutual Fund Distribution Surprise
Here’s a scenario that trips up newer investors every year. You own shares in a mutual fund, the fund’s price has dropped since you bought it, and you still receive a taxable capital gains distribution. This happens because the fund manager sold appreciated securities inside the fund during the year. You owe taxes on that distribution even though your personal investment is underwater.
Your unrealized loss on the fund can’t offset the distribution. The distribution is taxable income the year you receive it; your unrealized loss doesn’t exist for tax purposes until you sell your fund shares. If you’re thinking about buying into a mutual fund late in the year, check whether a large capital gains distribution is pending. Otherwise you could pay taxes on gains you never actually benefited from.