An unrealized loss is the drop in value of an investment you still own. If you paid $5,000 for a stock that’s now worth $4,000, you have a $1,000 unrealized loss. People call it a paper loss because nothing is locked in yet. It doesn’t touch your tax return, it doesn’t move cash out of your pocket, and it can reverse the moment prices do. But it still matters, and in a handful of specific situations it can hurt in very real ways.
How to Calculate It
Subtract the current market value from your cost basis. Cost basis is what you originally paid, including commissions and transaction fees. If market value is lower, the difference is an unrealized loss. If it’s higher, it’s an unrealized gain.
Buy 100 shares at $50 and you’ve spent $5,000. If the price falls to $40, your position is worth $4,000 and you’re sitting on a $1,000 unrealized loss. If it climbs to $65, you have a $1,500 unrealized gain instead. Either way, your tax return doesn’t change until you sell.
The same math applies to almost any asset with a fluctuating price: stocks, bonds, mutual funds, real estate, commodities, and cryptocurrency. The loss stays unrealized for as long as you hold.
When the Loss Becomes Real
Selling is the usual trigger. The moment your sell order executes and settles, the loss is final and reportable. Hold instead, and a price recovery can erase the loss entirely, or turn it into a gain.
You don’t always get to choose the timing. The IRS treats certain involuntary events as realization triggers: property that is destroyed, stolen, or condemned by a government authority generally produces a recognized gain or loss in the year it happens.1Internal Revenue Service. Involuntary Conversions: Real Estate Tax Tips Foreclosures work the same way. You can owe taxes or claim deductions without ever having voluntarily sold anything.
Why the IRS Ignores Unrealized Losses
The tax code only recognizes a capital loss when you dispose of the asset. You can’t deduct an unrealized loss, and it doesn’t reduce your tax bill no matter how deep it runs. 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 it. But you control when the loss becomes deductible, and that control is the basis for a strategy worth knowing.
Tax-Loss Harvesting
Tax-loss harvesting means deliberately selling an investment at a loss to generate a realized capital loss you can actually use. The realized loss offsets realized capital gains dollar for dollar. If your total losses exceed your total gains in the year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if you’re married filing separately).3Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
Any remaining net capital loss beyond the $3,000 cap carries forward to future tax years indefinitely.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses If you realize a $20,000 net loss this year with no gains to offset it, you deduct $3,000 now and carry $17,000 forward. You can chip away at it year by year or use the whole balance at once against a large future gain. The $3,000 limit, incidentally, has not been adjusted for inflation since 1978.
The Wash Sale Rule
There’s a catch. The IRS won’t let you sell at a loss and immediately buy the same thing 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. Including the sale date, 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 reaches further than many investors expect. Buying a call option on the same stock can trigger it. So can a repurchase in a spouse’s IRA or another account you control. The phrase “substantially identical” has no bright-line test; the IRS looks at facts and circumstances. In general, stocks of two different companies in the same industry are not considered substantially identical, and shares of one mutual fund are ordinarily not identical to another, even if they track similar indexes.
A disallowed wash-sale 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 shares in a clean transaction.
The Cryptocurrency Gap
By its statutory text, the wash sale rule applies only to “stock or securities.” Cryptocurrency is currently classified as property for federal tax purposes, not as a security. That means you can sell a crypto position at a loss and immediately buy the same coin back without triggering a disallowance.5Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities Crypto losses are unusually flexible for harvesting as a result, though tax law in this area is moving quickly and legislation could close the gap.
When a Stock Becomes Worthless
Occasionally an investment doesn’t just fall; it collapses. A company goes bankrupt, the stock is delisted, and your shares sit at $0.00 with no buyer. You haven’t sold, so how do you claim the loss?
The tax code treats worthless securities as if 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) You report the loss on Form 8949 like any other capital loss.
Proving true worthlessness is the hard part. The security must have no liquidating value and no realistic prospect of recovering any. A bankruptcy filing, cessation of operations, or sale of substantially all assets typically supports the case. If any argument exists that the company might come back, the IRS can challenge the deduction. Your holding period still matters: more than a year makes it a long-term loss, a year or less makes it short-term.
Paper Losses That Force Real Action
In a margin account, unrealized losses can stop being theoretical in a hurry. When you buy securities on margin, your broker lends you part of the purchase price. FINRA requires you to maintain equity of at least 25% of the current market value of your holdings, and many brokers set the bar higher at 30% or 40%.8FINRA. FINRA Rule 4210 – Margin Requirements
As unrealized losses mount, your account equity shrinks. Drop below the maintenance threshold and your broker issues a margin call, demanding more cash or securities. If you can’t meet it promptly, the broker can liquidate your positions without your consent, converting those paper losses into realized ones at the worst possible moment.
The Mutual Fund Distribution Trap
Here’s a scenario that catches people every year. You own shares in a mutual fund, the share price has dropped since you bought in, and the fund sends you a taxable capital gains distribution anyway. It happens because the fund manager sold appreciated holdings inside the fund during the year.
You owe tax on the distribution even though your own position is underwater. Your unrealized loss on the fund shares doesn’t exist for tax purposes until you sell them, so it can’t offset the distribution. If you’re thinking about buying into a mutual fund late in the year, check whether a large capital gains distribution is pending before you do. Otherwise you can end up paying tax on gains you never actually enjoyed.
How Unrealized Losses Vanish at Death
This is the scenario most investors never think about, and it’s where unrealized losses can be permanently destroyed. When you die, your heirs inherit your assets at fair market value on the date of death. The familiar version is the “step-up in basis” that benefits heirs who inherit appreciated property. The quieter version is the step-down: if an asset has lost value, the heir’s basis resets to the lower market price.9Office 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 die. Your heir inherits with a $30,000 basis. The $20,000 loss simply disappears. Nobody deducts it. Had you sold before death, you could have harvested that $20,000 to offset other gains or reduce ordinary income. After the asset passes through your estate, that chance is gone for good.
For someone with large unrealized losses and a terminal diagnosis or advanced age, selling depreciated holdings while still alive to capture the losses can be worth serious consideration. This step-down rule does not apply to inherited retirement accounts such as IRAs and 401(k)s, which follow different distribution rules.