A realized loss is the loss that is recognized when assets are sold for a price lower than the original purchase price. Realized loss occurs when an asset that was purchased at a level referred to as cost or book value is then disbursed for a value below its book value.
Key Takeaways
- A realized loss is the sale of an asset below the price at which it was acquired.
- This kind of recorded loss is available as a tax write-off for both individuals and businesses.
- Realized losses are different from unrealized losses that only exist on paper.
What is a Realized Loss?
When an investor buys a capital asset, an increase (or decrease) in the value of the security does not translate to a profit (or loss). The investor can only make a claim to a profit or loss after they have sold the security at fair market value in an arm’s length transaction.
Real-World Example of Realized Loss for Investors
Investor Scenario
For example, assume an investor purchases 50 shares of Exwhyzee (XYZ) at $249.50 per share on March 20. From this purchase date to April 9, the value of the stock declined by about 13.7% to $215.41. However, the investor only has a realized loss if they actually sell at the depressed price. Otherwise, the decline in value is simply an unrealized loss which only exists on paper.
The Impact on Taxes
Realized losses, unlike unrealized losses, can affect the amount of taxes owed. A realized capital loss can be used to offset capital gains for tax purposes. From our example above, the investor, after selling their XYZ stocks, realized a loss of 50 x ($249.50 - $215.41) = $1,704.50. Suppose they realized a profit on Aybeecee (ABC), which they purchased for $201.07 and sold for $336.06 during the same tax year.
If they purchased and sold 50 ABC shares, their capital gain on the transaction will be recognized as 50 x ($336.06 - $201.07) = $6,749.50. Applying the realized loss to this gain means that the investor will only owe taxes on $6,749.50 - $1,704.50 = $5,045, rather than the entire capital gains amount.
In addition, if the realized losses for a given tax year exceed the realized gains, up to $3,000 of the remaining losses can be deducted from the taxpayer’s taxable income. Also, if net losses exceed the given $3,000 limit, the remainder can be carried forward to future years.
This practice is called tax-loss harvesting, and discount brokers have added features to their desktop and mobile apps in recent years to help investors with this process.
How Realized Loss Works for Businesses
A realized loss occurs when the sale price of an asset is lower than its carrying amount. Although the asset may have been held on the balance sheet at a fair value level below cost, the loss only becomes realized once the asset is off the books. An asset is removed from the books when it is sold, scrapped, or donated by the company.
Tax Benefits for Businesses
One upside to a realized loss is the possible tax advantage. In most instances, a portion of the realized loss may be applied against a capital gain or realized profit to reduce taxes. This may be quite desirable for a company looking to limit its tax burden, and firms may actually go out of their way to realize losses in periods where their tax bill is expected to be higher than wished.
In effect, a business may choose to realize losses on as many assets as possible when it would otherwise have to pay taxes on realized profits or capital gains.
Related Terms: unrealized loss, capital gain, taxable income, tax-loss harvesting, tax-loss carryforward.
References
- Internal Revenue Service. “Publication 544 (2019), Sales and Other Dispositions of Assets”.
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
