Are Worthless Stocks Tax Deductible?

As experienced investors know, the stock market has its ups and downs. Risk is always a factor, especially if you trade individual stocks, and a hot tip can eventually turn into a dead loss if a company goes bankrupt. Fortunately, the Internal Revenue Service feels a bit of sympathy for your plight and gives you a consoling tax break for those worthless shares.

Capital Gains and Losses

The IRS capital gains rules apply to the trading of stocks. You report the activity and results on Schedule D. If you sell a stock at a profit, you must pay income tax at a rate that varies with long-term (stocks held more than a year) and short-term (less than a year) holdings. If you lose money on the trade, you can deduct the loss from your income.

Worthless Stock

If your stock has died and is not coming back, you can also report a loss even if you're unable to sell the shares. You report the purchase price normally on Schedule D, then list the selling price as 0 or "worthless." Since the proceeds are 0, you deduct the entire amount of the purchase, plus the commission you paid to buy the stock. The date of the closing transaction has to be December 31 of the tax year for which you're claiming the loss.

IRS Guidelines

Even if you can't sell the shares through a broker, the IRS doesn't necessarily see your stock as literally worthless. It all depends on the viability of the company that the shares represent. If the company is still operating under bankruptcy protection, for example, the shares may have not yet been canceled or liquidated. The market value may be a fraction of a cent, but a market still exists if the shares are trading.

Legal Transfer

You can avoid any questions by the IRS by selling the shares to another party -- such as a friend or family member -- if your broker is unable to complete a market trade. You would do this by obtaining the stock certificates, writing up a bill of sale, signing the certificates over to the buyer, and accepting payment for the sale. You then have a legally closed transaction and can report the loss on Schedule D. A stock transfer agent can accept the old shares and issue a new certificate in the buyer's name.