Rescue Tax Loss for Worthless Stock

Do you own stock that has become worthless in these uncertain times? At least you may be able to salvage some tax relief on your 2020 return.

Prepare to claim a capital loss for the worthless stock. The loss can offset capital gains racked up this year plus up to $3,000 of highly taxed ordinary income.

However, you must be able to establish that the stock is truly “worthless” in the year it’s claimed as such on a return.

To claim a deduction for worthless stock, you must show that the stock had value in the previous year and that an identifiable event – such as filing for bankruptcy – caused its value to drop to zero. 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. 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 for 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 becomes worthless. Claim the loss in the earliest year it’s reasonable to do so.

If you currently own stock that is on the verge of becoming worthless, you can sell it now to trigger a tax loss without having to worry about the worthlessness issue.

Caution: 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.

If you are stuck with trying to establish a loss due to worthlessness, keep all relevant records in case the IRS ever challenges your loss deduction. This includes financial statements indicating the date when the stock became worthless. Depending on your situation, you may have to go back in time.

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

Small Business Tax Strategies
October 2020