As the IRS notes, just about "everything you own and use for personal purposes, pleasure, or investment is a capital asset." Most people understand the concept best when related to stocks. When you purchase a stock, you generally experience an unrealized capital gain or loss, or both, at various times during your holding period. You also chance seeing a realized capital gain or loss. The type of gain you have dictates whether you report it to the IRS.
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If you purchase 100 shares of a stock for $5 per share, you have invested $500 plus commissions. Refer to the resulting number – call it $507.95 – as your cost basis. If the stock goes to $6 a share, its market value equals $600. Now, you have an unrealized capital gain of $92.05. If the stock drops to $4, its market value is $400. You have an unrealized capital loss of $107.95. In both cases, since you did not sell the stock, the IRS considers the subsequent gain or loss unrealized.
Unrealized Gains and Losses
You may have heard unrealized capital gains and losses referred to as "paper" gains or losses. Since you never "realized" these gains, they remain real only on paper. You do not have to report unrealized capital gains or losses to the IRS since you have no profit – essentially a form of taxable income – to report.
When to Report
If you were to sell 100 shares (or just partial shares) of a stock that rose from $5 to $6, you would report the difference between your proceeds, minus commissions, and the aforementioned cost basis. Report this as a capital gain on IRS Schedule D with your tax return. If you took, or "realized," a loss by selling the stock at $4 a share, you could report the difference between the cost basis and your proceeds from the sale, minus commissions, as a capital loss. The IRS allows filers to use capital losses to offset capital gains by up to $3,000. You can carry excess capital losses over to the next year.
If you realize a capital gain or loss because of a trade inside your IRA, you do not have to report it to the IRS. In fact, the IRS never lets you claim a capital loss for trades conducted inside an IRA. As far as capital gains go, the IRS may indirectly tax them. When you take a distribution from a traditional IRA, the IRS taxes the entire amount; therefore, it indirectly taxes any capital gains you realized. The IRS taxes earnings only on some Roth IRA withdrawals, depending primarily on timing and why you accessed the money. If some or all of those earnings are capital gains, again, the IRS indirectly taxes them. In both cases, this will occur at your regular income tax rate, not the capital gains tax rate, which the IRS uses to tax capital gains in the aforementioned non-IRA scenarios.