No investor wants to lose money, but it does happen. You may own stock in a firm that goes under, or you may get scammed by a Bernie Madoff.
Either way, the only thing left to do is memorize the lesson learned and make the most of the situation at tax time.
A worthless stock, typically shares in a company that went bankrupt, can be reported on the tax return as if it had been sold for nothing on Dec. 31, according to CCH Inc., a tax-information provider.
The taxpayer would use Dec. 31 to determine the stock’s holding period. If it had been held longer than a year, it would be a long-term capital loss, used to offset long-term capital gains on other investments that had been sold. Loss on a stock held for a shorter period would be a short-term loss, used to offset gains on other investments sold after being held for a year or less.
When losses exceed gains, they can be used to reduce ordinary income by as much as $3,000 a year. Losses that are bigger than that can be “carried forward” and used to reduce capital gains or income in future years.
To declare a stock to be worthless you must be sure it really is, CCH says. A stock that trades rarely or for only pennies a share is not worthless. To be worthless, it must not trade at all. To take a loss on a thinly-traded or penny stock, it must be sold.
Also, the stock’s worthlessness must be connected to an identifiable event, such as a bankruptcy, CCH says.
Losses from fraudulent investment schemes are treated differently — as theft rather than investment losses. This would include Ponzi schemes like Madoff’s, which cost thousands of investors billions of dollars.
More than 150 Ponzi schemes were uncovered in 2009, according to CCH. In a classic Ponzi, early investors receive phony profits from money paid in by later investors. These schemes usually collapse when too many investors want their money back, or when the con artist can’t find enough new investors.
The victim can claim the total amount lost minus any “profits,” “earnings” or recoveries received. Taxes on profits that were reported but later proved not to have existed can also be claimed.
A glance at the form shows you’ll need lots of documentation to support your claim, especially if you recovered money through a lawsuit or settlement, or if you collected some earnings and profits while the fraud was going on.
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