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Salvage Tax Loss for Worthless Stock

(posted: October 12th, 2015)

Woman tearing up stock certificate

Are you holding shares of stock that are now worthless? If so, you can realize some tax relief on your 2015 return.

Strategy: Prepare to claim a capital loss for the worthless stock. The loss can offset capital gains in 2015 plus up to $3,000 of highly taxed ordinary income.

However, you must be able to show the stock is truly "worthless." Timing can be critical.

Here's the whole story: To claim a deduction for worthless stock, you must be able to show that the stock had value in the previous year and that an identifiable event caused its value to drop to zero in the current year. A steep decline in the value of the stock, by itself, isn't sufficient. The stock must have no recognizable value.

A worthless stock is treated as if it had been sold on the last day of the tax year that it became worthless. Thus, the resulting loss is either short term or long term for stock held longer than one year.

You can claim the loss for worthless stock in the year it becomes worthless even if you sell it for a nominal amount the following year. If you can't determine that the stock has become worthless until a subsequent year, file an amended return for the year it actually became worthless. Because this determination is often difficult to make, claim the loss in the earliest year it's reasonable.

If you currently own stock that is on the verge of becoming worthless, a better policy might be to sell it now to trigger a loss without having to prove that the stock has become worthless.

Caveat: Don't sell the stock to a "related party" like a child or a corporation in which you own stock. If you do, the loss will be disallowed.

Finally, keep all relevant records in case the IRS ever challenges your loss deduction.

Tip: The usual three-year period for filing an amended return is extended to seven years for worthless stock losses.

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