As an investor it is common to have worthless securities and, in such cases, a taxpayer would prefer to claim a loss to reduce the amount of taxes due.
Here are a few general questions and two examples on investments in worthless securities:
- What is a worthless security as defined by IRS?
Worthless security is defined by IRC § 165(g) which includes the following:
- Share of stock in corporation;
- Right to subscribe for or to receive a share of stock in a corporation; or
- Bond, debenture, note or certificate or other evidence of indebtedness which earns you (taxpayer) a fixed sum of money.
- What are some examples of wholly worthless security and when to claim?
Example 1: In Year 1, Judy bought shares of Xetco Corp. for $5,000. In year 2, she received a formal notification that the shares became worthless. In such a case Judy will be able to claim a capital loss in the amount of $5,000 on her Year 2 tax return.
Example 2: In Year 1, Teddy bought 10 shares of HAU Corp. for $15 per share. HAU is a publicly traded company. Due to the global financial crisis the company share price declined to $10 per share in Year 2. In such a case Teddy cannot take a worthless stock deduction in Year 2 because the stock is not wholly worthless as evidenced by its trading value.
- When does a security becomes a wholly worthless security?
Security types mentioned above becomes wholly worthless security when abandoned and otherwise satisfies the requirements for a deductible loss under IRC § 165.
To abandon a security, a taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security.
All facts and circumstances with identifiable events need to be considered before making a determination on whether the transaction is properly characterized as an abandonment or potentially other type of transaction.
Due to complex nature of tax rules in this area, please be sure to make an appropriate consultation with your tax advisor before arriving at a conclusion.
Disclaimer: This information has been prepared for general informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors or consult us regarding your own personal tax situation as this article was intended to be general in nature.