What are Capital Losses?

Malcolm Tatum

Capital losses have to do with the realization of a loss on some type of capital investment. Essentially, capital losses takes place when the current selling price for the investment drops below the price originally paid by the investor. This would mean if the investor were to sell the investment, he or she would not be able to recoup the resources invested in the initial purchase.

Man climbing a rope
Man climbing a rope

Investors considering the purchase of stocks, bonds, and other securities often look at the past performance of the investment before making a commitment. As part of that evaluation, potential investors attempt to identify any periods over the last year to five years when the security posted a capital loss. Understanding when those periods occurred, along with the factors leading up to those periods where capital losses took place, can make it possible to determine if any current indicators point to the potential for another period of loss. If so, the investor may choose to delay the purchase or turn his or her attention to investing in other options.

Even with the most careful investigations, it is possible for investments of all types to incur capital losses. The loss may only be a temporary downward trend and the expectation is that the investment will soon recover and begin to increase in value once more. When this happens, the investor has to make a decision of whether to hold on to the security and ride out the low period, or sell the security at a loss before the price drops any further.

Along with incurring capital losses in connection with stocks and similar investments, it is also possible to experience a loss related to real estate holdings. As an example, a home is purchased for $300,000.00 US Dollars (USD) and has a current market value that is slightly higher. However changes in the interest rates coupled with some type of natural disaster causes the property to drop in value to $250,000.00 USD within that first year of ownership. As a result, the owner incurs a capital loss of $50,000.00 USD for that annual period.

Fortunately, many countries allow some sort of tax allowances in connection with capital losses. The total amount of the loss or at least a portion of the loss can often be claimed on tax returns covering the annual period. This type of deduction on taxes can help to offset capital gains earned during the period and thus decrease the overall tax burden. In some countries where it is not possible to claim the entire capital loss in one tax period, there are provisions that allow a percentage of the loss to be used as a deduction in later years.

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