Updated July 21, 2023
Definition of Realized Gain
Realized Gain is the gain realized or earned during the sale of an asset or investments when the selling price of the asset is greater than the purchase price or cost of acquisition of the asset and such gain is recorded in the books of accounts as the increase in the current asset of the entity and thus termed as ‘realized’ gain.
Formula
The formula can be shown as;
Where,
- SP: The selling price of the asset or stock; and
- COA: Cost of Acquisition of asset/stock or purchase price of the asset/stock
(Cost of Acquisition includes the original purchase price of the asset as well as any cost incurred for improvement of the working of the asset i.e., cost of improvement, cost of documentation, etc.)
Explanation
The market value of an asset can increase at any point in time during the life of the asset and it is not mandatory to be recorded into the books of accounts. But the gain that is realized when the asset in the books of entity is sold, is recorded in the books of the entity as an increase in the current assets of the entity and thus termed as ‘realized’ gain. In case there is only an increase in the market value of the entity, it may not necessarily be recorded in the books of the entity but such gain is marked as potential gain and called ‘unrealized’ gain.
How Does it Work?
This is always calculated when there is transfer in the ownership of the asset or investment i.e., sale of the asset. In case let’s assume Mr. Adam bought a land costing $1.5 million and later the year the market price of the land increase up to $2.5 million. Then, in this case, the increase in the price of the land won’t be recognized as gain as there is no transfer in the ownership of the land but it is only increasing in the market rate of the land. But in case Mr. Adam sells the land for $2.5 million then Mr. Adam would have earned $1 million and such would be considered as a realized gain.
Examples of Realized Gain
As the same has been explained above, let’s take an example of an enterprise ABC Inc. who has taken a plant costing initially $10000 and after the purchase of the plant, the enterprise has to incur some cost for making it suitable as per their requirement and making it work which amounts to $2500. After that, the enterprise decided to sell the plant to another corporate entity who offered an amount of $20000 for the plant. Comment on the realized gain for the enterprise.
Solution:
In the given case, ABC Inc. sold the plant, and thus such will be considered as the transfer of ownership and thus there will be the calculation of realized gain or loss.
Realized Gain = SP – COA
Where,
SP = $20000
COA = Original Purchase Price + Cost of Improvement
- COA = $10000 + $ 2500
- COA = $12500
Putting these values in the formula for calculation of realized gain;
- Realized Gain = $20000 – $12500
- Realized Gain = $7500
Hence the realized gain for the provided data will be $7500.
How are Realized Gains Taxed?
The earned for different classes of assets is taxed differently. Some of the cases are as follows:
- In case the gain has been realized on the sale of capital assets, then such realized gains are termed as capital gains and are taxed after the bifurcation of a capital gain into long term capital gain and short term capital gain. The capital gains are taxable in the income tax act.
- The gains realized in the sale of assets other than capital assets are taxed as in income from profit & gain from business headings in income tax act.
Difference Between Realized Gain and Unrealized Gain
- During the life of asset or investment, the market price of the asset kept increasing or decreasing or both. At the time of sale of the asset if the selling price is greater than that of the original cost of acquisition of the asset, then the amount of difference between the both is termed as the same. Whereas during the course when the asset is kept by the assessee if the market price of the asset is more than the original acquisition cost of the asset then the excess amount is treated as unrealized gain.
- This is recorded in the books of accounts of the assessee whereas unrealized gain is not treated in books of accounts.
- This is taxable whereas unrealized gain is not taxable in nature.
Advantages and Disadvantages
Below are the advantages and disadvantages:
Advantages
There are some advantages of realizing gain during the sale:
- Realizing gain during the sale of assets or commodities or stock increases the surplus or current asset of the entity which results in a stronger financial statement.
- This amount could be used by the entity to further increase its business coverage area or business activity.
- This could be used to set off any carry forwarded losses of previous years of the organization.
- The more the market price of the asset, the more the assessee can gain from the asset.
Disadvantages
- They are taxable in nature so all the incomes received from this nature attract tax and the assessee has to pay tax as per the rate applicable.
- Markets are volatile in nature so it is possible that the market rate of the asset may increase further after the selling point and thus the assessee may lose its substantial potential gain from the asset.
Conclusion
The gain is termed ‘realized gain’ when the asset or commodity or stock has been sold with the ownership of the asset has been transferred and the amount realized from the sale is more than the original cost of acquisition of the asset. The excess amount is called as ‘the same’. The attract tax and the more the tax would be. The carryforward losses or the losses incurred during the year can be set off from the earned during the year.
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