What it means
Assets fall in value as well as rise. When the fall is crystallised by a sale, the resulting loss has two lives: one in the accounts and one in the tax computation.
In the accounts, the loss on disposal is proceeds less the carrying amount of the asset. If an asset has been depreciated or impaired, its carrying amount already reflects a lower value, so the loss on sale is only the additional shortfall.
A large loss on disposal is a signal that earlier depreciation or impairment was inadequate, and auditors and analysts read it that way. Losses on disposal, like gains, are presented separately from revenue and operating costs so that the underlying trading result is visible.
In tax, a capital loss is computed from the tax cost base, which may differ from the accounting carrying amount. Most tax systems ring-fence capital losses: they can be set against capital gains of the same year, and any excess is carried forward to set against future capital gains, but they cannot reduce trading income or salary, or only within small limits (the United States allows individuals to offset up to $3,000 of ordinary income a year; many countries allow none).
Some systems restrict the use of losses further: losses on transactions with connected persons may be usable only against gains from the same person; losses created shortly before a change of ownership may be blocked; and losses on certain assets (a main residence, personal chattels) are not allowable at all because gains on them are not taxable. Because losses are valuable only when there are gains to absorb them, timing matters.
Realising a loss in a year with no gains produces a carried-forward figure that may not be used for years; realising it in the same year as a large gain saves tax immediately. Investors sometimes sell loss-making holdings before a year end to offset gains realised earlier, a practice called loss harvesting, though anti-avoidance rules in many countries deny the loss if the same asset is repurchased within a short period (the wash sale rule in the US, the bed-and-breakfasting rules in the UK).
Unrealised losses, where an asset has fallen in value but has not been sold, are treated differently again. In the accounts, an impairment review may require the carrying amount to be written down, producing an impairment loss without a disposal.
For tax, no loss arises until disposal, unless the asset has become of negligible value and a claim is made to treat it as sold. The gap between an unrealised loss in the accounts and its eventual tax recognition is one of the sources of deferred tax assets, which are recognised only if future gains to use the losses against are probable.
In practice
Real-world examples.
Example
An individual sells shares at a $12,000 loss in December to offset a $15,000 gain realised earlier in the year, and is careful not to buy the same shares back within the restricted period.
Example
A company writes off its investment in a failed subsidiary as a capital loss, usable only against future capital gains, not against its trading profits.
Example
A property fund sells a building for $8 million against a cost base of $11 million and carries the $3 million loss forward against gains on later sales.
Think of it
“Capital losses are losses from selling investments for less than you paid-the opposite of capital gains.
Formula
Calculation
Capital Loss = Cost base minus Disposal proceeds (where proceeds are lower)
Accounting loss on disposal = Carrying amount minus Net proceeds
Tax saving from a loss = Loss used x Capital gains tax rate
Worked example. A company holds three investments and property, and in the current year makes the following disposals:
- Shares in Company X: cost $400,000, sold for $150,000. Loss $250,000.
- Shares in Company Y: cost $200,000, sold for $380,000. Gain $180,000.
- A machine: original cost $90,000, carrying amount after depreciation $30,000, tax written-down value $20,000, sold for $12,000.
Accounting: loss on disposal of X shares $250,000; gain on Y shares $180,000; loss on machine = $30,000 minus $12,000 = $18,000. Net loss on disposals shown in the income statement: $88,000, below operating profit.
Tax (illustrative regime: capital gains tax at 20%; losses offset against gains of the year, excess carried forward; the machine falls under the capital allowances regime, not capital gains, producing a balancing allowance of $20,000 minus $12,000 = $8,000 against trading income):
- Capital gains: $180,000
- Capital losses: $250,000
- Net: loss of $70,000 carried forward; no capital gains tax payable this year
- Tax saved this year by the loss = $180,000 x 20% = $36,000
- Future value of the carried-forward loss = $70,000 x 20% = $14,000, if and when gains arise
Deferred tax: the company recognises a deferred tax asset of $14,000 for the carried-forward loss only if it expects capital gains within a foreseeable period; it has a property it plans to sell in two years at an expected gain of $300,000, so the asset is recognised.
Timing alternative: had the company held the X shares into the following year and sold both X and the property then, the $250,000 loss would offset the $300,000 property gain, but the $180,000 Y gain this year would have been taxed in full ($36,000). Selling X this year was the better sequence.Case study
Seen in the real world.
A manufacturing group had accumulated $4,200,000 of capital losses over a decade from disposals of underperforming subsidiaries and a failed property venture. The losses sat in a note to the accounts, unrecognised as a deferred tax asset because the group had no plans that would generate capital gains, and the tax team regarded them as worthless. A new group finance director reviewed the group's property portfolio and found that its head office building, bought twenty years earlier for $3,000,000, was worth about $9,000,000, and that the group had been considering a sale and leaseback to fund expansion but had rejected it partly because of the $1,200,000 of tax the gain would attract.
With the losses, the gain of $6,000,000 would be reduced to $1,800,000 and the tax to $360,000. The sale and leaseback went ahead, released $9,000,000 of cash, and used the losses that had been considered dead.
The finance director also found that one of the loss-making disposals had been made to a connected company, which restricted $500,000 of the losses to gains from that same company; those remained unused. Her note to the audit committee recommended that capital losses be tracked in a register with their restrictions, reviewed annually against planned disposals, and treated as an asset to be used rather than a footnote to be forgotten.
Watch out
Common mistakes.
- Expecting capital losses to reduce income tax on trading profits or salary. In most systems they offset only capital gains.
- Realising a loss and then repurchasing the same asset within the restricted period, which cancels the loss for tax.
- Forgetting carried-forward losses, or their restrictions, when planning a disposal that will produce a gain.
Questions
People also ask.
Do capital losses expire?
In many systems they carry forward indefinitely; some impose time limits or restrict use after a change of ownership. Check the local rules.
Can I claim a loss on an asset that has become worthless but not been sold?
Many systems allow a negligible value claim treating the asset as sold at its worthless value, crystallising the loss without a disposal.
Is an impairment the same as a capital loss?
No. An impairment is an accounting write-down of an asset still held. A capital loss for tax generally requires a disposal, and the two figures often differ.
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