A short-term loss occurs when an investor loses money on an investment within the first year after acquiring that particular asset. This is in contrast to long-term losses, which take place when a loss is incurred on an asset that has been in the possession of the investor for more than one calendar year. Understanding the difference between a short-term and a long-term loss is important when calculating a capital loss to report on the annual income tax return.
In order to realize a short-term loss, the investor must acquire the asset at some point during the year, then sell that asset at a loss at a later time in that same year. The loss is not considered realized for tax purposes until the sale is complete. This means that in many nations, investors who may actually see an investment lose value during that first year but choose to hold onto the investment for another year cannot claim a short-term loss. Even if the asset is sold the following year, ownership has exceeded the one-year mark and the loss is considered a long-term capital loss rather than a short-term loss.
Claiming a short-term loss on a tax return typically requires submitting specific forms that are used to report any capital gains or losses that are incurred during the tax year in question. Documentation to back up the data included on the form must be kept on file, in the event that the tax or revenue agency reviewing the tax return has any questions regarding when the asset was acquired, when it was sold, and the amount of loss that occurred. Keeping the documentation on hand makes it much easier to justify the claim in the event that an audit should take place.
It is important to note that investors sometimes choose to hold onto an asset that has experienced a decrease in value rather than claim the tax breaks associated with a short-term loss. This is especially true if there is reason to believe the asset will recover in a reasonable period of time, and possibly increase in worth over the long-term. The amount of tax benefits derived from the claim will also influence the decision of the investor. Should a review of current tax laws and the financial position of the investor indicate that it would be better to hold onto the asset long enough to claim it as a long-term loss, there is a good chance that the investment will not be sold until the following tax year.
