The proposal would have taxed billionaires on those unrealized gains. If shares of Amazon or Facebook or Berkshire Hathaway rise 20 percent in a year, Jeff Bezos, Mark Zuckerberg or Warren Buffett, respectively, would owe taxes on that gain — even if they don’t sell a single share. Assets that are harder to value, such as privately held companies or real estate, would also be subject to tax.
Part of the objection to the billionaire’s tax was that it is a dramatic change from the current tax system, which taxes people only when they realize gains.
That’s untrue. There are several provisions in the current tax code through which unrealized gains are taxed.
Here’s one example of something in the code today. Certain hedge fund managers can do what’s called a 475 election, a maneuver named after Section 475 of the tax code. Using this provision, their entire fund is taxed on its market value at the end of the year. They have to pay taxes on gains, whether they sell the underlying stock or not. Are these hedge fund managers nuts? Nope. They do it because it confers several benefits for certain types of funds (particularly those doing rapid-fire trading every nanosecond), including freeing them from complying with trading rules they may find onerous.
Hedge fund managers are intimately familiar with the concept of placing a value on unrealized gains. Their compensation depends on it. Each year, they get a small percentage, typically 2 percent, of the assets they manage. If they do well and the fund goes up, they get a performance fee, often 20 percent of the increase in the fund’s value. How do they determine that 20 percent? They figure out the unrealized gains. On Dec. 31, they tell their clients that their assets went up and get paid 20 percent of that amount. If those stocks fall on Jan. 1, they don’t have to give the money back.
The mirror image of unrealized gains also exists in the tax code. Today, businesses that buy equipment get to take a deduction intended to approximate the amount that it loses in value each year. This concept is called depreciation. In other words, you get a deduction based on an estimate, not when you sell something. You could call it an unrealized loss.
And then there’s the wealth tax on unrealized gains that millions of Americans already pay: property taxes, which every owner of a house or apartment is responsible for. Property taxes are a town or city’s estimate of the value of your home or land, almost always in a year you didn’t sell.