Question: My accountant keeps telling me about my unrealized profits. What exactly are they? Are they a positive or a negative?

Eleanor T.

Answer:

Dear Eleanor,

I have good news for you. Profits, whether realized or unrealized are always a positive. Here's what you need to know to have a meaningful conversation with your accountant.

The Definition

An unrealized profit is one that has been made on paper but not actually "realized" through a transaction. That transaction is typically a stock transaction. In other words, you have a profit on paper because your stock has gone up in price since you initially purchased it, yet you still own the shares. Unrealized profits are usually not taxable.

However, when you sell your shares, the profit becomes taxable. The amount of tax you must pay is based on how long you've held your investment, your tax bracket and the type of investment being sold.

For example, stocks held long term are taxed at a lower rate than those held short term. Your accountant can crunch these numbers for you.

Avoiding Taxation With Tax-Free Investments

Not all realized profits are taxed at every level. That's because some investments are partially or fully tax exempt. Keep in mind, however, that tax-free investments typically yield less than comparable investments that produce taxable earnings. Among investments that are partially or fully tax free are:

• Tax-free money market funds
  
  
• Tax-free mutual funds
  
  
• Tax-free municipal bonds -- interest earned is exempt from federal income tax and state and local taxes to residents of the area where issued; however, realized gains when made upon selling are subject to federal income tax and most state income taxes.
  
  
• U.S. Savings Bonds -- these are free of state and local taxes; federal tax can be deferred until bonds are redeemed or mature and if used to pay for college, they are also free of federal income tax.
  
  
• U.S. Treasury bonds -- they are exempt from state and local income taxes.

Other Unrealized Profits

You might also have unrealized or paper profits if you own real estate or precious metals that have increased in value, or perhaps works of art, antiques, a coin collection or other collectibles.

$TIP: Don't be lured into thinking you're rich -- a profit is not a profit until it becomes realized!

If you have additional questions on this, or any other topic, feel free to write in again.

Good luck!