What is “Capital Loss”?
A capital loss is a loss realized when a capital asset is sold below its purchase price. Examples of capital assets include equity shares, bonds, property, and plant & equipment. Capital losses can be adjusted against any taxable capital gains made by a company during the same accounting period. If there are not enough capital gains to offset the capital losses, then such losses can be carried forward to future years in most countries.
Key Learning Points
- A capital loss is a loss realized upon selling a capital asset below its purchase price
- Capital losses can be realized on capital assets such as equity shares, bonds, property, plant, and equipment (PP&E)
- Capital losses can be used to offset capital gains for tax purposes – the accounting rules for capital losses differ from country to country
- In the US, capital losses can be carried back up to 3 years and carried forward up to 5 years to offset any capital gains during this period
Capital Loss Formula
A capital loss is calculated as:
Capital loss = Purchase Price of a Capital Asset – Sale Price of Capital Asset
If a company has purchased an asset for US$75,000 and later sells it for US$50,000, it incurs a capital loss of US$25,000. On the other hand, If the asset were sold for US$100,000, then the company would make a capital gain of US$25,000. Short-term capital losses or gains are made on capital assets held for a duration of one year or less. Long-term capital losses or gains are made on capital assets held for more than one year.
Companies are required to account for capital losses and gains separately from their regular corporate income. Capital losses offset capital gains, and the remaining amount is considered for taxation purposes. For example, if a company has capital gains of US$50,000 and capital losses of US$30,000, then the net capital gain is US$20,000. This amount would be added to the company’s taxable income.
Reporting and Taxation of Capital Losses
The accounting rules related to capital losses vary from country to country. In the UK, a capital loss may occur if an asset is not sold but is considered disposed of legally. This can happen if an asset is destroyed or loses its value. Further, in the UK, capital losses can be used to offset capital gains arising in the same period (i.e. in the same tax year) but It cannot be carried back to offset capital gains of earlier years for claiming tax refunds. Capital losses cannot be typically used to offset a company’s ordinary income.
In the US, capital losses of a corporation are permitted in the current tax year (i.e. current period) only to the extent of capital gains. Further, there (US), net capital losses can be carried back 3 years and carried forward up to 5 years as a short-term capital loss. The same can be used to offset any capital gains. When offsetting against capital gains, the capital losses that arose are utilized first.
Capital Loss Example
Given below is some financial information on a US-based company. Using this data we can look at how the capital loss is calculated that can be carried forward to future years.
Here, the net capital loss of US$80,000 in 2019 can be carried back to offset the capital gains of 2016 and 2017 (i.e. US$40,000 + US$40,000). It is worth noting that the offsetting is done with the earliest year first rather than the most recent year.
Next, the net capital loss of US$250,000 in 2020 can be carried back to offset the capital gain of US$60,000 in 2018 and carried forward to offset the capital gain of $50,000 in 2021. As a result,net capital loss of US$140,000 (i.e. US$250,000 – US$60,000 – US$50,000) is available for carrying forward.
As mentioned above, in the US, net capital losses can be carried forward up to five years. Therefore, since this loss was made in 2020, it can be carried forward between 2022 and 2025.