DEFINITION of Recognized Loss
When an investment or asset is sold for less than its purchase price. Recognized losses may be reported for income tax purposes and then carried over into future periods.
BREAKING DOWN Recognized Loss
Recognized capital losses can be used for effective tax planning strategies. For example, if an investor has taxable capital gains for a given year of $10,500 and is able to recognize a loss on another investment for $2,500, this loss can be applied against the taxable capital gains. Therefore, this investor's net taxable capital gains for the year are $8,000 rather then $10,500. Recognized losses can also be applied to future years. For example, if a company has no taxable income in a given year, recognized losses may offset taxes on profits for up to a certain number of years.
Tax loss harvesting uses recognized capital losses to potentially offset or reduce taxable income, which is particularly useful to investors already planning to sell off an undesirable investment and replace it with a more attractive one, in order to diversify or rebalance a portfolio. This may include selling off shares in a fund that has underperformed, or it may pertain to a real estate property that become burdensome. In any case, in using recognized losses to enrage in tax liability reduction it is generally not recommended to harvest losses in excess of current-year gains, plus an amount to offset ordinary income.
A like-kind exchange occurs when two taxpayers exchange similar assets, such as trading of two rental properties. This technique may used to usher in an intentional future loss, when a taxpayer knowingly exchanges his or property for one that is less valuable. However the recognized capital loss would only kick in when the investor later sells off the new asset.
It is important for investors to distinguish "recognized losses" from "realized losses", when calculating taxes, following the disposition of an investment or asset. The two terms are often confused, however their differences are of paramount importance. Simply put: a loss is realized immediately after an investor completes a transaction but has no impact on his or her taxes. Contrarily, a recognized loss is one that may be deducted from your taxes. Most investment asset sales create both realized and recognized losses simultaneously—typically immediately following the transaction. The IRS delays the tax impact of certain transactions, which are specifically listed in the tax code. If a sale has a delayed tax impact, it will create a realized loss but not a recognized loss.