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A lot of taxable liabilities depend on the notion of when a monetary gain is "realized", but it is not clear to me how this is defined legally.

For example, if a person sells stock, then the brokerage will credit the cash account of the client. The client does not actually have the money in the sense that the brokerage "owes" them the money, but since the brokerage can be viewed as sort of a bank, then the gain could be considered realized.

So, take a different kind of debt. A gambler wins money at a casino, but just has chips. If the gambler keeps the chips, obviously the chips are not "money" so the gain cannot be said to be "realized". Now, suppose the gambler cashes the chips, but only to his account at the casino. The casino now owes the money to the gambler but has not paid it. The casino is not a bank, so the customer's balance is a commercial debt, not money.

So, if you consider that to be a "realized" gain of money, does that mean any business credit is? For example, if a vendor issues a business a new credit for some reason, then is that gain "realized" as soon as the vendor notifies the business of the credit, or only when the business receives a check for the credit and actually deposits it in its bank account?

For example, if I sell something to a business, they owe me the money for the good, but that is not a "realized" gain yet, until they actual pay me and the money is in my bank account.

So, basically the question revolves around possession of money and whether one can be said to "possess" money owed by a bank, casino, other business, person, or whatever.

One pretty obvious rule here is that only one person can possess the cash. So, either the cash belongs to me or the casino, not both, for example. If the casino is actually holding my money in a separate entitled account which is "mine", then I guess theoretically the money is "mine", but if the casino just considers my "account" to be just a ledger entry, then the cash does not really exist. It's just a debt they have to me, so it cannot be considered to be "realized".

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    This is not really a legal question in my opinion. It's more of an accounting question. There are, however, two standard ways that debts are realized by a company, accrual vs. cash. Either one is equally valid but legally you need to be consistent.
    – jwh20
    Dec 7, 2022 at 14:22
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    @jwh20 I guess if the IRS prosecutes me for not reporting a "realized" gain, then it becomes a legal question what "realized" means then, isn't it? Do I need to get jailed before I ask here?
    – Cicero
    Dec 7, 2022 at 14:29
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    That was not the question you asked. Please edit your question and rephrase to something like "if I follow improper accounting procedures and use that information on my tax filing, what laws might I run afoul of?"
    – jwh20
    Dec 7, 2022 at 14:52
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    This is very much a legal question, and is full on-topic here, alkthopgfuih it could also be addressed on other SE sites. Dec 7, 2022 at 15:10
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    Under the doctrine of constructive receipt, if you receive a check on Dec 31, but it's snowing out and so you don't deposit it in your bank until jan 3rd, it's still taxable income in the prior year. The money doesn't leave the payer's account until it's deposited (or cashed) but it's still taxable income to the payee in the year it's received. It may be true from a legal perspective that only one person can possess the cash, but from a tax accounting perspective, it depends.
    – stannius
    Dec 7, 2022 at 23:03

3 Answers 3

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In general, a liquid account, denominated in monetary units (dollars, pounds, euros, etc) from which the owner has the right to make a withdrawal at any time is treated legally much the same as cash. This includes a bank account and a brokerage 'cash" account. It will not include a mutual fund account denominated in shares of stock, nor a debt which is not collectable at will. When the proceeds of a transaction are depositd into such an account, I believe that the profit (if any)m has been "realized" and that a taxable event has occurred.

Under 26 U.S.C. § 1001 a gain or loss is realized on the sale or other disposition, or exchange of property. Nothing is ssid about 'cash" or accounts with a signature authority.

Under 26 CFR 1.1001-1:

... the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained.

in Cottage Savings Ass'n v. Comm. of Internal Revenue, 499 U.S. 554, 559 (1991) The US Supreme Court wrote:

Rather than assessing tax liability on the basis of annual fluctuations in the value of a taxpayer's property, the Internal Revenue Code defers the tax consequences of a gain or loss in property value until the taxpayer "realizes" the gain or loss. The realization requirement is implicit in § 1001(a) of the Code, 26 U. S. C. § 1001(a), which defines "[t]he gain [or loss] from the sale or other disposition of property" as the difference between "the amount realized" from the sale or disposition of the property and its "adjusted basis." As this Court has recognized, the concept of realization is "founded on administrative convenience." Helvering v. Horst, 311 U. S. 112, 116 (1940).

...

Section 1001(a)'s language provides a straightforward test for realization: to realize a gain or loss in the value of property, the taxpayer must engage in a "sale or other disposition of [the] property." The parties agree that the exchange of participation interests in this case cannot be characterized as a "sale" under § 1001(a); the issue before us is whether the transaction constitutes a "disposition of property."

...

Neither the language nor the history of the Code indicates whether and to what extent property exchanged must differ to count as a "disposition of property" under § 1001(a). Nonetheless, we readily agree with the Commissioner that an exchange of property gives rise to a realization event under § 1001(a) only if the properties exchanged are "materially different."...

...

We start with the classic treatment of realization in Eisner v. Macomber, supra. In Macomber, a taxpayer who owned 2,200 shares of stock in a company received another 1,100 shares from the company as part of a *pro rata- stock dividend meant to reflect the company's growth in value. At issue was whether the stock dividend constituted taxable income. We held that it did not, because no gain was realized.

...

In Phellis and Marr, we held that the transactions were realization events. We reasoned that because a company incorporated in one State has "different rights and powers" from one incorporated in a different State, the taxpayers inPhellis and Marr acquired through the transactions property that was "materially different" from what they previously had. United States v. Phellis, 257 U. S., at 169-173;

...

Taken together, Phellis, Marr, and Weiss stand for the principle that properties are "different" in the sense that is "material" to the Internal Revenue Code so long as their respective possessors enjoy legal entitlements that are different in kind or extent. Thus, separate groups of stock are not materially different if they confer "the same proportional interest of the same character in the same corporation." Marr v. United States, 268 U. S., at 540. However, they are materially different if they are issued by different corporations, id., at 541; United States v. Phellis, supra, at 173, or if they confer "differen[t] rights and powers" in the same corporation, Marr v. United States, supra, at 541. No more demanding a standard than this is necessary in order to satisfy the administrative purposes underlying the realization requirement in § 1001(a). See Helvering v. Horst, 311 U. S., at 116. For, as long as the property entitlements are not identical, their exchange will allow both the Commissioner and the transacting taxpayer easily to fix the appreciated or depreciated values of the property relative to their tax bases

Thus any exchange of property for other property which is in some significant sense different, such as interests in different mortgages of similar market value, or any sale of property causes a gain or loss to be realized.It does not matter in what sort of account the proceeds are held, or even whether the proceeds are in cash as opposed to some other sort of property. The beneficial owner realizes a gain or loss, even if s/he is not the legal owner.

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  • Well, from a legal point of view, what is the law or legal principle when the cash become "yours"? For example, I can spend the cash in a brokerage account directly. But cash in a casino account, can ony be spent at the casino. I can't buy a big screen TV out of my casino account. Likewise, if I have a credit at a utility company, I can use it to pay a utility bill, but nothing else. If the utiliy company goes bankrupt, then I lose "my" so it really wasn't mine was it? Where is the legal dividing line between a person "possessing" the cash versus somebody else "owing" the cash to me?
    – Cicero
    Dec 7, 2022 at 19:40
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    Once the money is in an account from which you have the right to make a cash withdrawal on demand, it is clearly "yours" and has been realized. This world clearly include the brokerage account, and probably the casino account. It might include the utility account. For tax purposes, once money is credited to an account identified as "yours" and that carries no investment risk, I believe it is treated as having been realized. Dec 7, 2022 at 19:54
  • @Cicero how did this hypothetical utility credit get into your account? If it was a return of previous fees paid, it's not income. If it's wages for work you did for the utility, I think it's taxable when you receive it, even though it can't be converted to cash (effectively it's barter income).
    – stannius
    Dec 7, 2022 at 22:44
  • What's the difference between a bank deposit and a debt which is collectible at will? Bank deposits are debt from the bank. Is it just the convenience of collecting the debt? What if one holds treasuries? What if one has a cryptocurrency account holding Tether? Tether is mostly backed by treasuries - so why should the answer be different.
    – user253751
    Dec 8, 2022 at 10:19
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For example, if a person sells stock, then the brokerage will credit the cash account of the client. The client does not actually have the money in the sense that the brokerage "owes" them the money, but since the brokerage can be viewed as sort of a bank, then the gain could be considered realized.

Gain is realized when the stock is sold. A cash account has no risk of loss and is available on demand.

So, take a different kind of debt. A gambler wins money at a casino, but just has chips. If the gambler keeps the chips, obviously the chips are not "money" so the gain cannot be said to be "realized". Now, suppose the gambler cashes the chips, but only to his account at the casino. The casino now owes the money to the gambler but has not paid it. The casino is not a bank, so the customer's balance is a commercial debt, not money.

Again, the gain is realized not later than when the chips are turned into the casino or removed from the casino (whichever comes first)m, arguably when the chips are won. Again, the key points are that there is no risk of loss and the chips can be converted to cash on demand.

So, if you consider that to be a "realized" gain of money, does that mean any business credit is? For example, if a vendor issues a business a new credit for some reason, then is that gain "realized" as soon as the vendor notifies the business of the credit, or only when the business receives a check for the credit and actually deposits it in its bank account?

For example, if I sell something to a business, they owe me the money for the good, but that is not a "realized" gain yet, until they actual pay me and the money is in my bank account.

This depends upon the method of accounting you elect for tax purposes.

If you are an accrual basis accounting taxpayer, you have gain when the sale is made and the business credit obligation to you arises, and you take a bad debt deduction if the credit is not paid.

If you are a cash basis accounting taxpayer, you have gain only when the other business pays you, e.g., by delivering to you a check or an electronic payment or currency or a barter item in lieu of cash.

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  • Well this can't be right, because there are lots of things that can be "converted into cash on demand" but are not considered to be realized gains. For example, if I have a convertible warrant that gains in value (say due to a maturation), then that is not considered to be a "realized" gain, even though the warrant is convertible to cash. It is not until I actually do the conversion and receive the cash that the gain is considered to be realized.
    – Cicero
    Dec 7, 2022 at 18:20
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    @Cicero In the case of a convertible warrant there is a risk of loss (or more generally, a risk of change in value) until it is exercised.
    – ohwilleke
    Dec 7, 2022 at 22:04
  • If I bought and sold some crypto and thus received cash in my account at FTX, did I realize the capital gain?
    – A. Rex
    Dec 8, 2022 at 2:56
  • @A.Rex Yes. You did realize capital gain.
    – ohwilleke
    Dec 8, 2022 at 3:42
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    The answers at the end of the day to why two very similar looking transactions have different tax consequences is 'because the IRS says so'. There are all sorts of peculiarities in the tax code that are logically inconsistent. Many intentionally so. Arguably the tax difference between crypto swaps and cash fx swaps is one.
    – Chuu
    Dec 8, 2022 at 14:50
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Researching this further I see there is a Wikipedia article on the Amount Realized. They specifically state there that the amount is realized when a "realization event" occurs. In the CFR covering this issue, they do specifically define at one point the "cash" becomes the property of the seller which is crucial to the definition. So, they just stipulate that to be realized, the asset must be converted to "cash", which I suppose is supposed to mean US dollars, since they don't define what is meant by "cash".

Legal guidance often state that the person must "receive" the money. So, I guess the presumption is that the money must be in a negotiable account over which the person has signatory authority. So, that would disbar both the casino and the utility examples, and might even disbar transfer accounts like PayPal because technically I don't believe a PayPal user has signatory authority over their funds. They essentially have to "request" that PayPal transfer the funds, and PayPal itself is the sole signatory over those funds.

So, there are some aspects of the question that are still unresolved.

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  • First, it seems to me that a PayPal user does have "signature authority" over his account in any reasonable sense of the term: they can instruct PayPal on what to do with the funds in that account just as they can instruct a bank holding an account over which they have signature authority what to do with those funds. ¶ Second, I suspect that merely having an interest in the account is enough to be considered to have received the money.
    – cjs
    Dec 8, 2022 at 8:58
  • That is simply untrue. From a legal point of view, PayPal users have no legal authority over their money. In fact, the money of PayPal users is not even in separate accounts, but is only in large slush fund accounts that only PayPal authorized agents, I am sure, have signatory authority over. PayPal can at any time refuse to make a payment on behalf of their clients for arbitrary reasons. That's why they are called a "transfer agent", not a "bank". The bottom line here is that you are just making offhand opinions, not citing any legal authority. The whole question is about a legal definition.
    – Cicero
    Dec 8, 2022 at 13:39

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