A recognized loss is sustained by selling an asset for less than the accounting basis. The basis includes the purchase price and any improvements made to the asset since. Such losses can be reported on taxes and deducted from capital gains in order to reduce overall tax liability. They must be handled carefully to make sure they are documented correctly and to avoid any problems with tax authorities that might arise from improper reporting techniques.
In an example, an investor might buy a piece of real estate for $100,000 US Dollars (USD) and make another $50,000 USD worth of improvements, bringing the basis to $150,000 USD. The investor hangs on to the property, and is forced to sell it in a down market for $120,000 USD. This results in a recognized loss, because the investor sold it for less than it was worth. Investors can report the recognized loss on their taxes.
Assets may be sold for less than the accounting basis for a variety of reasons. One issue is lack of liquidity which forces investors to sell assets immediately to get cash, even if they can’t get the best price for them. Investors may also decide to sell if the value appears to be dropping in order to avoid taking a bigger loss. Liquidation sales can also result in similar kinds of losses because companies need to sell off their assets quickly and cannot afford to time the sale for the best economic conditions.
When a recognized loss occurs in a year where a company has no capital gains, it may be possible to offset it to another tax year. The best option can depend on the type of sale and the tax situation. An accountant can review the documentation to provide advice on how to handle it; it can also help to meet with an accountant prior to a planned sale to discuss tax implications and determine if it is possible to adjust the timing of a sale for a better tax outcome.
The opposite of a recognized loss is a recognized gain, where an asset is sold for more than the basis and the seller profits. In the example above, if the investor sells the property for $200,000 USD, a capital gain has been made on the difference between the basis and the sale price. Investors must report their gains and pay taxes on them and may choose to time sales in order to offset gains with losses to avoid paying taxes.
