A capital loss deduction allows taxpayers to offset the decline in the value of an asset and reduce taxable income. Tax codes vary by jurisdiction and may limit deductions to investment property, such as stocks, bonds, and rental real estate.
A capital loss deduction is a reduction in taxable income that is allowed by a taxing authority to offset a decline in the value of an asset. Many countries and regions tax income, including income from the appreciation of all types of assets. Income from an item is determined at the time it is sold or transferred to another party by comparing the sale price with the original purchase price when the asset was acquired. The change in value is either a capital loss or a capital gain. If the sale results in a loss, many jurisdictions allow the amount of the loss to be deducted from other income.
Each jurisdiction has its own tax code that reflects how it taxes its residents. These codes detail how assets are treated for income tax purposes in those jurisdictions that assess an income tax. Assets are all things owned by a person or entity, including real estate, personal property, and investments. Tax codes refer to these items as capital assets and designate rules to determine how to tax the appreciation in value of the asset over time.
A capital asset can increase or decrease in value over time. If the value of the asset increases, the owner must pay capital gains tax on the increase during the year in which he sells or transfers the item. It is also possible for an asset to decrease in value. Decreases result in capital losses and may generate tax benefits in the form of deductions from other income for the amount of the loss. This results in the owner paying less tax overall to make up for the loss.
The rules governing a capital loss deduction may be different in each jurisdiction. In the United States, for example, a capital loss deduction can be applied to other income, such as wages, up to a certain amount. If the loss is more than the allowable deduction for the year, the balance can be carried over and applied to income in the next and subsequent years, until the loss has been fully allocated. In some cases, this can be a significant benefit to a taxpayer that fully offsets the financial impact of an asset’s loss in value.
Another typical restriction on a capital loss deduction in a jurisdiction like the United States is to limit the deduction to investment property. If a loss occurs on an item of personal property, such as a car, the owner cannot take a capital loss deduction. The deduction only applies to property held for investment purposes, such as stocks, bonds, and rental real estate.
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