Capital Loss

What is Capital Loss?

Capital loss is the reduction in the value of a company’s capital, i.e., investments, capital assets, etc. The loss is realized when capital assets are sold for a price lower than the original price.

How to Calculate Capital Loss

The formula for capital loss is as follows:

Capital Loss = Purchase Price – Sale Price

If the sale price is higher than the purchase price, it is referred to as a capital gain.

Practical Example

For example, say, ABC Ltd. plans on expanding its manufacturing unit. For such a purpose, the company purchases a factory worth $800,000. Ten years later, the company decides to sell the factory to upgrade to a larger one.

The business sells the factory for $740,000. Applying the capital loss formula with the information available:

$800,000 – $740,000 = $60,000

Hence, the company realizes a capital loss of $60,000 from the sale.

Holding Period

The holding period for an investment or a capital asset is the time period between the purchase and sale of a capital asset, i.e., the period of time that the asset is held by the investor. This holding period is crucial for taxation purposes on capital gains and losses. Regarding the holding period of the capital assets, capital losses are divided into two categories:

• Short-term capital losses (less than one year)
• Long-term capital losses (one year or longer)

Capital losses are required to be categorized into long-term and short-term types before reporting them on tax returns.

Accounting for Capital Losses

Capital losses are first accounted for against capital gains in the sense that they are first used to offset any corresponding capital gains of the same type earned during the year. Hence, all short-term capital losses are treated as a deduction against all short-term capital gains, and all long-term capital losses against long-term capital gains.

The net capital loss arising out of the deductions is subtracted from the company’s income through subsequent years as a carry forward of the remaining capital loss balance. While it is how accounting for capital loss is generally practiced around the world, many countries adhere to their own set of rules and regulations regarding taxation and capital loss accounting on income.

Tax Deductibility

Capital loss is tax-deductible. It means that capital losses can be used to reduce total income subject to taxation. However, capital losses are deductible only when realized, not when accrued. Hence, until the capital asset is physically sold, the accrued capital loss is unrealized and becomes realizable only upon the literal sale of the asset.

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Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

• Accrual Principle
• Financial Accounting Theory
• Return on Capital Employed (ROCE)
• Types of Assets

See all Accounting resources