What Are Worthless Securities?

What Are Worthless Securities?

Let me explain worthless securities directly to you: these are stocks, bonds, or other holdings that have absolutely no market value, whether they're publicly traded or privately held. If you're dealing with one, the IRS advises treating it as if you sold or exchanged it on the last day of the tax year. You'll need to determine your holding period first— that's key to figuring out if your capital loss is short-term (one year or less) or long-term (more than one year).

For a short-term loss, report it on Part I of Schedule D, where you can net your short-term gains and losses to find the overall short-term result. Long-term losses go on Part II of Schedule D, and you net those similarly. Once that's done, combine the nets from both parts for your total capital gain or loss.

A Quick Tip on Tax Strategy

You might find it useful to incorporate a worthless security into a tax-selling strategy. This is where you sell an asset at a capital loss to reduce or wipe out capital gains from other investments—it's a straightforward way to manage your tax burden.

Understanding Worthless Securities

Let's dive into how these work. For public companies, market value comes from multiplying outstanding shares by the current price, giving you market capitalization. Private companies use methods like comparable analysis or discounted cash flows for valuation. Worthless securities hit zero on this scale.

For a security to truly be worthless, it must not only lack current value but also have no realistic chance of recovering any. A stock might drop to zero due to market swings, but if the company could bounce back, it's not worthless yet. However, if bankruptcy shuts the doors permanently, that stock is likely done for.

Worthless Stocks vs. Penny Stocks

Don't confuse worthless stocks with penny stocks. Worthless ones have a flat zero market value, while penny stocks typically trade below $5 per share. Penny stocks can certainly turn worthless, but they start with some value and often trade on OTC markets or pink sheets due to their low price.

These penny stocks are speculative and risky, with issues like low liquidity, wide bid-ask spreads, small market caps, and limited information available. That's why they're high-risk investments.

How Do I Report Worthless Securities?

If you've got a worthless security, file it on IRS Form 8949. Have your purchase date, the date it became worthless (treated as sold), and the amounts paid and received ready—it's essential for accurate reporting.

When Can You Claim a Worthless Stock?

Claim it in the tax year it actually becomes worthless. That's the straightforward rule from the IRS.

How Are Worthless Securities Taxed?

They're treated as capital losses, so you claim them in the year they go worthless. This offsets other gains, and the holding period decides if it's short- or long-term.