Are you holding shares of stock that have become worthless? At least you may be able to obtain some tax relief for this downturn on your 2023 return. Strategy: Prepare to claim a capital loss for the worthless stock. The loss can offset capital gains in 2023 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 a worthlessness loss is claimed on your return. Timing in this area 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. A steep decline in the market value of the stock by itself isn’t sufficient. To be worthless, the stock must have no recognizable value. A worthless stock is treated as if it had been sold for zero on the last day of the tax year. Thus, the resulting loss is either short-term or longterm 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 became worthless. Because this determination is often difficult to make, claim the loss in the earliest year that it’s reasonable. If you currently own stock that is on the verge of becoming worthless, sell it now to trigger a tax loss that is beyond dispute. 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. This includes financial statements or other proof 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.