What is capital loss?
Capital loss refers to the loss in value that occurs when selling or investing capital assets for less than their original price. The loss of capital will be realized if the asset is sold for a price less than the purchase price.
For instance, if an investor purchases a real estate that costs USD 500 million and sells it 10 years later for USD 400 million, the investor realizes a capital loss of USD 100 million.
Short-term vs long-term capital loss
There are two types of capital losses depending on the period of the purchase: short-term and long-term.
A short-term capital loss is when the investor owns an investment for less than a year. On the other hand, a long-term capital loss is when the investor owns an investment for more than a year.
3 categories of capital losses
Business owners or investors can regain the capital losses by deducting them from tax returns, subject to certain conditions. Capital gains are reported as the investor’s income and are usually used to offset the losses.
Capital losses can be divided into three categories:
Realized losses pertain to the loss when the asset is sold for less than its purchase price. The capital loss will only be realized if the asset the investors or business owners sold is an “arm’s length transaction, donated, or scrapped.”
Investors’ losses may influence the changes in tax rates. It is somehow desirable for the companies that want to limit their tax burden.
Unrealized losses refer to the loss of paper profit that results from holding or declining certain assets that have not yet been sold but have decreased in price.
For instance, a company owns an investment that costs USD 500,000; however, there is a decrease in the market value at USD 300,000. The company has an unrealized loss of USD 200,000.
Usually, business owners and investors would let go of the capital loss hoping that the price of an asset might eventually return. With that said, an unrealized loss is a theoretical loss but can be calculated for a specific period of time.
Recognized loss refers to the loss of an asset or investment sold for an amount less than its purchase value. This may influence the capital gain treatment. Recognized loss may be reported for tax purposes.
There is a distinction between “realized loss” and “recognized loss.” Realized loss is when the investor or business owner realizes the capital loss immediately after the transaction yet has no effect on their taxes. However, the recognized loss is a loss subject to deduction from capital gains.
Whatever the case, business owners and inventors still sell the asset even though the investment has already decreased in value. That way, they can determine the loss itself, which allows them to strategize to avoid the huge loss in the future and reduce tax obligations.