Subject to certain limitations, the Internal Revenue Service allows you to deduct the value of your capital losses from your taxable income. In some cases, however, you may have to wait several years to deduct the full value of your loss.
When stock you purchased becomes worthless, you incur a capital loss that you can deduct from capital gains and, in many cases, some of your other income.
Worthless Securities and Your Taxes
Normally, you must actually incur a capital loss before you can deduct it. In other words, you must actually sell your stock for less than what you paid for it. However, if your stock becomes worthless – because the corporation that issued it dissolved, for example, the IRS still allows you to claim a loss.
Your capital loss typically equals the stock's adjusted basis minus its sale price. The adjusted basis normally equals the price you paid for the stock plus any other amounts you had to pay to purchase the stock, such as broker's fees. If you cannot sell your stock because it is worthless, the IRS allows you assign a sale price of zero and use this figure to calculate your capital loss. If you sold your stock for pennies, on the other hand, you should use the actual sale price to calculate your loss. To the IRS worthless stock is that which is actually worth $0, not close to $0.
To calculate your capital loss, you must aggregate the total capital gains and losses that arose from your sale of investment property during the tax year. If you gained $40,000 on the sale of commercial real estate and lost $27,000 on the stock market, for example, you may write off your stock market losses only against your $40,000 gain, leaving you a net capital gain of $13,000. If, on the other hand, you lost $67,000 on the stock market, you have net capital loss of $27,000 for the year.
Limitations on the Worthless Stock Deduction from Ordinary Income
Whether the losses are from worthless securities or from other sales of investment property at a loss, you may deduct no more than $3,000 in net capital losses against ordinary income in any one tax year – $1,500 if you are married and filing separately – but you can carry forward your excess losses indefinitely. You report capital losses on Form 8949, Form 1040 and Schedule D. Prepare documentation that proves the stock is worthless and establishes the approximate date on which it became worthless. You don't have to submit this documentation with your tax return, but you will need it if the IRS audits you.
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.