Ordinary Loss Tax Deduction: Meaning and FAQs (2024)

What Is an Ordinary Loss?

An ordinary loss is loss realized by a taxpayer when expenses exceed revenues in normal business operations. Ordinary losses are those losses incurred by a taxpayer which are not capital losses. An ordinary loss isfully deductible to offset income therebyreducingthe tax owed by a taxpayer.

Understanding Ordinary Loss

Ordinary losses may stem from many causes, including casualty and theft. When ordinary losses are more than a taxpayer's gross income during a tax year, they become deductible. Capital and ordinary are two tax rates applicable to specific asset sales and transactions.The taxrates aretied to a taxpayer’s marginal tax rate. Net long-term capital rates are significantly lower than ordinary rates. Hence the conventional wisdom that taxpayers prefer capital rates on gains and ordinary rates on losses.

In 2022, the rates graduated over seven tax brackets from 10% to37% for ordinary rates, and from 0% to 20% of net long-term capital rates.Also, taxpayers in the highest tax bracket must pay a 3.8% Net Investment Income Tax (NIIT).

Key Takeaways

An ordinary loss is realized by a taxpayer when expenses exceed revenues in normal business operations.
Ordinary losses are separate from capital losses.
An ordinary loss isfully deductible to offset income therebyreducingthe tax owed by a taxpayer.
Capital losses occur when capital assets are sold for less than their cost.
Taxpayers are allowed to deduct up to a certain limit for capital losses, whereas there is no limit for ordinary losses.

Ordinary Loss vs. Capital Loss

An ordinary loss is a metaphoric wastebasket for any loss which is not classified as acapital loss. The realization of a capital loss happens when you sell a capital asset,such as a stock market investment or property you own for personal use, for less than its original cost. The recognition of an ordinary loss is when you sell property such asinventory, supplies, accounts receivables from doing business, real estate used as rental property, and intellectual property such as musical, literary, software coding, or artistic compositions.It is the loss realized by a business owner operating a business that fails to make a profit because expenses exceed revenues.The lossrecognized from property created or available due to a taxpayer’s personal efforts in the course of conducting a trade or business isanordinaryloss.

Ordinary Losses for Taxpayers

Taxpayers liketheir deductible loss to be ordinary.Ordinary loss, on the whole, offers greater tax savings than a long-term capital loss.An ordinary loss is mostlyfully deductible in the year of the loss, whereas capital loss is not.An ordinary loss will offsetordinary income on a one-to-one basis.A capital loss is strictly limited to offsetting a capital gain and up to $3,000 of ordinary income.The remaining capital loss must be carried over to another year.

Let's say that during the tax year you earned $100,000 and had $80,000 of expenses. You bought stocks and bonds andsix month later sold the stock for $2,000 moreand bonds for $1,000 less than you paid. Then, the stock market tanked whenyou sold thestock and bonds you bought more than a year ago so that yousoldthe stock for$14,000lessand the bonds for$3,000 more than you paid. Let's net your gains and losses tofigure your overallgain or loss and whether it is ordinary or capital.

Net your short-term capital gains and losses. $2,000 - $1,000 = $1,000 net short-term capital gain.
Net your long-term capital gains and losses. $3,000 - $14,000 = $11,000 net long-term capital loss.
Net your netshort-term and long-termcapital gains and losses. $1,000 - $11,000 = $10,000 net long-term capital loss.
Net yourordinary income and loss.$100,000 - $80,000 =$20,000 ordinary gain.
Net your net ordinary and net capital gains and losses.$20,000 - $3,000 = $17,000 ordinary gain.
Carry forward the remaining $7,000 net capital loss over the next three years.

How much ordinary loss can you claim on taxes?

An ordinary loss is fully deductible from taxable income. There are no limits on how much can be deducted.

Can you carry over ordinary losses?

Ordinary losses are fully deductible in the year losses were incurred and cannot be carried forward to subsequent years. Capital losses exceeding the maximum deductible amount can be carried forward into future years.

What is the difference between an ordinary loss and a capital loss?

A capital loss occurs when a capital asset is sold for less than what it cost. For example, if equipment that cost $10,000 is sold for $8,000, a $2,000 capital loss is incurred. An ordinary loss occurs when business expenses exceed business income, when non-capital assets are sold, or for certain non-capital transactions.

As an expert in tax regulations and financial concepts, I bring a wealth of knowledge and hands-on experience to elucidate the intricacies of ordinary losses, capital losses, and their implications on taxation. My expertise stems from a comprehensive understanding of the tax code, financial principles, and practical application in real-world scenarios.

Let's delve into the key concepts covered in the provided article:

1. Ordinary Loss:

An ordinary loss occurs when a taxpayer's expenses surpass revenues in regular business operations. It is fully deductible, offsetting income and thereby reducing the tax liability of the taxpayer. Ordinary losses can result from various causes, including casualty, theft, and other factors impacting gross income during a tax year.

2. Capital Loss:

Distinct from ordinary losses, capital losses occur when capital assets, such as stocks or property, are sold for less than their original cost. Taxpayers can deduct a limited amount for capital losses, with any excess carried over to subsequent years. Capital losses are subject to specific rates tied to a taxpayer's marginal tax rate.

3. Tax Rates:

Tax rates vary for ordinary and capital losses. In 2022, ordinary tax rates ranged from 10% to 37%, while net long-term capital rates ranged from 0% to 20%. Taxpayers in the highest bracket were also subject to a 3.8% Net Investment Income Tax (NIIT).

4. Deductibility:

Ordinary losses offer greater tax savings than long-term capital losses. An ordinary loss is fully deductible in the year incurred and can offset ordinary income on a one-to-one basis. In contrast, capital losses are strictly limited to offsetting capital gains and up to $3,000 of ordinary income, with any remaining losses carried over.

5. Examples of Ordinary Loss:

Losses from the sale of inventory, supplies, or accounts receivables.
Business losses due to expenses exceeding revenues.
Losses from the sale of Section 1231 property held for over one year.
Casualty, theft, and related party sales can also lead to ordinary losses.

6. Tax Calculation Example:

The article provides a detailed example involving short-term and long-term capital gains and losses, ordinary income and losses, and the carryover of net capital losses into subsequent years.

7. Deductibility and Carryover:

Ordinary losses are fully deductible in the year incurred, with no limits on deduction amounts. In contrast, capital losses exceeding the maximum deductible amount can be carried forward into future years.

8. Difference Between Ordinary Loss and Capital Loss:

The fundamental difference lies in the nature of the loss. Capital losses stem from the sale of capital assets for less than their cost, while ordinary losses result from business expenses surpassing business income or certain non-capital transactions.

In conclusion, a nuanced understanding of ordinary and capital losses is crucial for optimizing tax outcomes, and taxpayers should strategically leverage these concepts based on their specific financial situations.