Taxing Unrealized Capital Gains: Deducting Unrealized Capital Losses
Unrealized capital gains have long been a topic of debate among investors and policymakers in the United States. With the possibility of taxing these gains on the horizon, one question frequently arises: can investors offset their losses with those same gains?
Understanding Unrealized Capital Gains and Losses
Unrealized capital gains and losses refer to the gains or losses in the value of an investment that have not yet been realized through the sale of the asset. While it is tempting to think that these losses can be deducted against unrealized gains, the reality is more complex. According to tax laws, you cannot currently deduct unrealized capital losses against your unrealized capital gains.
The Current System of Taxation
Generally, taxes are only applied to realized capital gains. This means that you only pay taxes on capital gains once you have sold the investment and realized the gain in the market. The Internal Revenue Service (IRS) currently does not allow for the offsetting of unrealized losses against unrealized gains. Therefore, if you have an unrealized loss, you can only claim it as a loss against your ordinary income, limited to $3,000 per year.
Proposed Changes and Their Impact
Legislative proposals, such as Kamala Harris's plan, suggest that unrealized capital gains may be taxed. Theoretically, if this were to pass, that could mean that losses could potentially be deducted against these gains. However, such a move is highly unlikely for practical reasons.
Kamala Harris's proposal seems driven more by political ideology than practical economics. The rationale behind this plan is not to improve the tax system but, as she has publicly stated, to weaken capitalism and create an environment conducive to implementing communism. While such a move would theoretically result in the loss of trillions of dollars in wealth, including assets such as 401ks, college savings accounts, and pension funds, it is politically unrealistic.
Practical Considerations
The proposed change in tax laws for unrealized capital gains would only affect a small number of tax returns—approximately 2,000 per year. Furthermore, for those affected, the effective tax rate would need to be less than 25%. This further reduces the likelihood of such a proposal being enacted.
Limitations and Alternatives
One argument against taxing unrealized capital gains is that it penalizes investors for making investments that have not yet been realized. If a company’s stock price drops but the investor hasn’t sold their holdings, taxing the unrealized gains doesn’t make sense, as the investor cannot use those gains until they sell.
An alternative to taxing unrealized capital gains is to adopt mark to market accounting. Mark to market accounting allows investors to report the current market value of their investments as the value at the end of the accounting period, similar to how professional traders operate. However, many investors and accountants recommend against this approach as it introduces more volatility and potential inaccuracies into the tax system.
Conclusion
While the idea of deducting unrealized capital losses against unrealized capital gains is intriguing, current tax laws do not permit this. The economic and political implications of such a change would be significant and politically challenging. For the time being, investors should continue to focus on realized gains and losses, as outlined in the current tax laws.
As always, consulting with a tax professional or financial advisor is crucial in navigating complex tax laws and finding the best strategies for your individual situation.