A recognized loss refers to a decrease in value of an asset that has been realized through a sale or other disposition and is reported on the taxpayer’s income statement or tax return. In essence, it’s the amount by which the selling price of the asset falls short of its adjusted basis (typically, its purchase price adjusted for factors like improvements, depreciation, etc.). When this loss is “recognized,” it becomes reportable for tax purposes in that year.
Much like with gains, there’s a distinction between a “realized” loss and a “recognized” loss:
- Realized Loss: This is the difference between the adjusted basis of the asset and its selling price, regardless of whether the loss is reported on the income statement or not.
- Recognized Loss: This is the portion of the realized loss that is reported on the income statement or tax return and thus can potentially provide tax relief.
Certain tax provisions may restrict or delay the recognition of some realized losses.
Example of a Recognized Loss
Let’s further illustrate the concept of a recognized loss with another example.
Lisa purchased a piece of artwork three years ago as an investment for $20,000. Due to changing tastes in the art market, the value of her artwork decreased. She recently found a buyer who was willing to purchase it, but only for $12,000. Lisa decided to sell the artwork at this price.
Calculating Realized and Recognized Loss:
- Realized Loss:
- Purchase Price of Artwork = $20,000
- Selling Price of Artwork = $12,000
- Realized Loss = Purchase Price – Selling Price
- Realized Loss = $20,000 – $12,000 = $8,000
Lisa has a realized loss of $8,000 from selling the artwork.
- Recognized Loss:
For this example, let’s assume that there are no special tax provisions or restrictions that would prevent Lisa from claiming the loss. As such, the entire realized loss becomes recognized.
Recognized Loss = $8,000
Lisa would report this recognized loss of $8,000 on her tax return for the year. Depending on her country’s tax regulations, this loss might offset other capital gains she had during the year, reducing the taxes owed on those gains. If she had no other capital gains, some tax systems might allow her to deduct the loss from her ordinary income or carry it forward to offset future gains.
In this scenario, the realized loss and the recognized loss are the same, as Lisa is able to claim the entire loss on her tax return. However, as with gains, certain tax codes and situations might prevent the full realization of a loss from being recognized in a given year.