Ordinary Loss: Meaning & Definition

KEY TAKEAWAYS

• An ordinary loss gets realized by a taxpayer if the expenses that are incurred exceed the total amount of revenue generated through business operations.
• Ordinary losses are usually fully deductible when you file a tax return, reducing the amount of tax owed. 
• You can deduct a certain amount when it comes to capital losses, but there is no limit to the amount that can get deducted for ordinary losses.
• Capital losses happen when a capital asset is sold for less than what it originally cost.

What Is an Ordinary Loss?

An ordinary loss happens when the expenses outweigh the revenues earned in normal business operations. These losses get realized by taxpayers and are only incurred on a property that is acquired in a normal course of business for sale to clients, such as inventory, stocks in trade, or accounts receivable.

Typically, ordinary losses are able to get fully deducted when you submit a tax return. This can help offset your income and reduce the total amount of tax that you owe. There can be several causes and reasons for ordinary loss, including theft and casualty that affected business property.

How to Calculate Ordinary Loss

Calculating ordinary loss treatment can be fairly straightforward as long as you have the necessary information. There can be some external factors to be aware of, such as the stock market dropping and exchanges of stocks. 

The simplest way to calculate ordinary loss for individual taxpayers is to find the difference between the initial purchase price for a stock or bond and the amount you sell it for (sale price). 

For example, let’s say that you purchase a stock for $1,000. Unfortunately, when you decide to sell the stock the stock market takes a tumble and you’re only able to sell the stock for $800, which is $200 less than you initially invested. Therefore, the loss from investment, or your ordinary loss, would be $200.

Ordinary Loss vs. Capital Loss

While sometimes ordinary and capital loss can seem as though they’re intertwined, they work differently. Essentially, ordinary loss relates to anything that cannot be classified as a capital loss. 

Realizing a short-term capital loss occurs when you decide to sell a capital asset that you have owned for 1 year or less, such as a property you own or a stock market investment. However, you receive less than the original cost of the asset because of the rules for capital loss. If you hold a capital asset for longer than 1 year, the loss from its sale is generally categorized as long term.

Recognizing an ordinary loss occurs after the sale of business property. This can include supplies, inventory, real estate, intellectual property, and others. Business owners recognize this loss because they were unable to make a profit since the expenses exceeded the revenues. As well, ordinary loss can also stem from a few other circumstances. These can include theft and casualty. 

It’s also worth noting that a capital loss is fully deductible against capital gain plus up to $3,000 of ordinary income, such as wages, dividends, and interest reported on Form 1040.

Ordinary Loss From a Taxpayer’s Viewpoint 

More often than not, a taxpayer is going to want their deductible losses to be ordinary losses. This is because an ordinary loss will provide more tax savings compared to what you could receive from a long-term capital loss. 

Ordinary losses typically get deducted within the year the losses were incurred. They fully offset ordinary income and cannot be carried forward, unlike capital losses.

Tax Deductions on Ordinary Loss 

Any losses that are incurred from business operations should never get offset against any capital gains. Ordinary losses stem from normal business operations that result in expenses exceeding income. Plus, ordinary losses can also occur because of a net loss. 

A 1231 loss involves any losses that occur from a depreciable business property, such as land, buildings, and machinery. With all of that said, an ordinary loss is 100% deductible within the year that it occurs. It’s not subject to the same $3,000 limit for capital losses or other types of losses.

Summary 

An ordinary loss happens when the expenses a taxpayer incurs exceed the revenues that get generated through business operations. Ordinary losses are 100% deductible within the same year that they occur. Some examples of stocks include industrial stocks and tech stocks.

Both capital losses and ordinary losses have specific tax rates for transactions and asset sales. These rates coincide with a taxpayer’s marginal tax rate. Ordinary losses also work separately from capital losses. Capital losses happen when a capital asset is sold for less than what it originally cost. As well, capital losses can only get realized up to a total of $3,000, and can be carried forward and claimed in subsequent years.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.