When is a Worthless Stock Worthless
Writing Off Worthless Stock Investments
Nobody likes to see his/her stock investment decline in value. It is even worse when the hopefully next Apple or Google stock declares bankruptcy. Is there some solace in that the stock investment can be written off as worthless for tax reporting purposes?
While taxpayers can write off as a deductible tax loss a wholly worthless security held by them, they cannot claim a loss when the stock becomes partially worthless. The challenge is to determine the year in which the stock becomes wholly worthless. The loss can be claimed only in the year that it becomes wholly worthless, and the burden of proof to prove worthlessness is on the taxpayer. So how does a taxpayer determine the year the stock became worthless?
Some would argue that when the company declares bankruptcy, it is worthless. The IRS would disagree because it says that bankruptcy proceedings don’t necessarily establish complete worthless of a company’s stock. For example, some bankrupt companies may be delisted off the major stock exchanges but trade on the over-the-counter (OTC) market via a system called “pink sheets.” Since these stocks often trade for a few cents, they are only partially worthless and thus do not meet the wholly worthless test.
The investor has a few choices. The easiest is to sell the shares while still listed on a major stock exchange. The sale will generate a loss. While the investor will receive something for the stock, the tax rules allow the investor to claim a tax loss in the year of sale. A partial loss may be better than waiting for years to prove when the stock became wholly worthless. Some cash is better than no cash, and a tax loss is better than no tax loss.
Deciding when to claim the loss is something that should be discussed with your tax professional who better understands the tax rules and your options.
What happens if you decide to hold onto the shares only to discover years later that you waited too long to claim the loss (at least in the eyes of the IRS)? There still may be some hope. Because of the fact that it is very difficult to determine the exact year of the loss, Sec. 6511(d)(1) of the Internal Revenue Code provides taxpayers with an additional four years to claim the loss. In other words, whereas taxpayers normally have 3 years to file an amended tax return to claim an unreported capital loss from a prior year, this Code section provides the taxpayer with a 7-year look-back period.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.