Recognized loss definition
/What is a Recognized Loss?
A recognized loss occurs when an asset is sold for an amount less than its purchase price. This situation most commonly arises when an entity sells either a security or property. Depending on the nature of the asset and the circumstances of the sale, a recognized loss may qualify for capital gains treatment, which means that the loss can be deducted from any capital gains reported for tax purposes. Capital gains treatment is usually available if the underlying asset was retained for at least one year.
Recognized losses can be incorporated into tax planning. For example, when a taxpayer has a recognized capital gain of $10,000, it can make sense to recognize a $4,000 loss on a different investment, in order to reduce the capital gain for tax purposes.
Characteristics of a Recognized Loss
The key characteristics of a recognized loss are as follows:
Financial impact. A recognized loss directly impacts the income statement, decreasing net income for the period.
Accounting recognition. Recognized losses are recorded in the financial statements in the period when they occur, as required by the matching principle.
Result of an event or transaction. A recognized loss arises from events such as natural disasters, market declines, or theft. It can also result from operational inefficiencies, asset impairments, or litigation outcomes.
Measurable and realizable. A recognized loss must be measurable and based on reliable data or estimates.
Linked to asset or liability changes. A recognized loss often results from the impairment, sale, or disposal of assets at amounts below their book value. It can also be due to the recognition of contingent liabilities, penalties, or adverse legal outcomes.
Non-recoverable. Recognized losses are typically permanent reductions in value and are not expected to be recovered.
Immediate recognition. Recognized losses must be recorded promptly when the triggering event occurs or becomes evident. They cannot be deferred to future periods unless allowed by specific accounting standards.
Disclosed in financial statements. Recognized losses are reported and often accompanied by disclosures in the notes to the financial statements.
Example of a Recognized Loss
Alyssa purchased a rental property several years ago as an investment, paying $400,000 for it. Because of changes in the zoning laws near this property, its value has declined to $380,000. Her unrecognized loss at this point is $20,000. A few months later, she finds a buyer who is willing to pay $370,000 for the property. She agrees to the deal, and incurs a recognized loss of $30,000 on the property. She can report this $30,000 loss on her tax return for the year in which the sale occurred.