Claiming a Loss for Worthless Securities

All stock pickers make mistakes, and sooner or later they make a really big one, investing in what turn out to be worthless securities.

As a general rule, you can’t claim a loss on a stock investment until you sell the shares. What happens if the stock becomes completely worthless, so that a sale is no longer possible? The answer is that you’re allowed to claim the loss in the year the stock became worthless — but only under a strict rule that poses problems for many taxpayers.

The rule described here is for worthless securities, a term that includes bonds as well as shares of stock.

Worse than worthless

Capital Gains, Minimal Taxes: The Essential Guide for Investors and Traders

There are two big problems with the rule for worthless securities. One is that you can be stuck in a situation where the investment has no value to you, but it doesn’t qualify as a worthless security under the tax law. You don’t want it and you can’t sell it. You’re left singing the Dan Hicks classic, How Can I Miss You When You Won’t Go Away.

What’s more, the way this rule works, it can be difficult to determine when the deduction is allowed. If you claim it too soon, the IRS can disallow the deduction. But the same is true if you wait too long. It’s like the riddle of the Sphinx: answer incorrectly and you face dire consequences.

That’s why nearly worthless stock can be worse than worthless. You know your money is down the drain, but you may have a long wait before you can claim a deduction. On top of that, you have the hassle of trying to figure out exactly when the deduction is allowed, and the risk that the IRS will disagree with your judgment.

A word to the wise. As with many of life’s troubles, the best way out of this situation is to avoid getting in it. When you see one of your investments take a major hit, the tendency is to think you can recover your loss by holding on. More often than not, the best recovery available is the tax deduction you can establish by selling the stock.

Special accounts

You can’t claim a loss for worthless securities that were held in your IRA. The same goes for stock held in your 401k account. In these accounts you don’t have to pay tax when you have a gain, so you don’t get to claim a deduction when you have a loss.

If the loss occurs in a custodial account for a minor child (sometimes called an UTMA or UGMA account), a deduction may be allowed, but it has to be reported on the minor’s tax return. Often the minor has little or no income, so the deduction doesn’t do any good. Nevertheless, it simply isn’t possible for a parent or other adult to claim this loss: it belongs to the child.

Really, really worthless

You can’t claim a loss for stock until it’s worthless. Completely worthless. And this is the heart of the problem.

A stock that’s in serious enough trouble will fail to meet the requirements for trading on a stock exchange. It will be delisted, which means you can no longer sell these shares in a normal transaction. For a period of time, though, it’s possible that speculators will be willing to purchase shares at some dirt-cheap price, hoping they’ll end up having at least a little value. Bids for these shares may be available through a quotation system known as the pink sheets. As a result, your shares are not worthless securities. They’re just nearly worthless.

If you’re in this situation, you may be able to establish your loss by selling the shares for a nominal amount. Even if there are no buyers, your broker may be willing to purchase the shares for a dollar. Too often, though, the cost of selling the shares is greater than the amount you can receive in a sale, and in some cases there isn’t any practical way at all to make a sale. You’re left in a kind of tax purgatory where you can’t claim the loss until it finally becomes clear that the value of the shares has fallen all the way to zero.

It gets worse

It isn’t enough to show that your stock was entirely worthless in the year you claimed your deduction. You also have to show that it was not entirely worthless in the preceding year. You aren’t allowed to choose which year you claim the loss. You have to claim it in that single, unique year in which the stock changed from being almost-but-not-quite-worthless to utterly-without-doubt-worthless.

As a general rule, you need an “identifiable event” that establishes the worthlessness of the stock. Bankruptcy can qualify — it appears that old WorldCom shares became worthless when the company (now MCI) came out of bankruptcy in April 2004, because the court’s ruling extinguished all rights of the former shareholders — but stock can retain some value even during and after a bankruptcy. You may need another event that establishes zero value for your shares, such as liquidation of the corporation or events indicating it has gone out of business with no assets left to distribute.

Dealing with uncertainty

You may find yourself in a situation where it simply isn’t clear whether your shares continue to have any value. You don’t know whether to claim your loss this year or wait for a sign from the heavens. There are two pieces of standard advice for people in this situation, although neither one gives a great solution.

One is to try to sell the shares, perhaps to a cooperative broker, as described earlier. You may not find a way to do that, or the cost of doing it may be more than you want to pay. And you aren’t necessarily home free even if you succeed. Technically, if the shares became worthless in an earlier year (before you sold them), you’re required to claim the loss in that earlier year, and the loss you claimed on the sale of the shares can be disallowed.

The other standard piece of advice is based on a frequently quoted opinion by a sympathetic judge. Noting the taxpayer’s dilemma, the judge wrote that the only safe practice would be “to claim a loss for the earliest year when it may possibly be allowed and to renew the claim in subsequent years if there is any reasonable chance of its being applicable for those years.” (Young case, 2d Cir. 1941). Apparently you would “renew the claim in subsequent years” only if the IRS disallowed the earlier claim, since you can’t double claim the loss. In any event, the special statute of limitations for this type of loss (see below) takes some of the pressure off, so it probably isn’t a good idea to claim the loss in a year when it may seem possible, but highly dubious, that the stock has become worthless.

Nowadays we can search the Internet for information about companies. If the stock is no longer listed on an exchange, check for a pink sheet listing or other indication that the shares still have value. Ideally, you want to document three things:

  • The stock had no value at the end of the year you claimed the deduction.
  • An identifiable event occurred, establishing worthlessness.
  • The stock still had some value at the end of the preceding year.


At long last, in 2008, the Treasury adopted regulations saying you can establish the worthlessness of securities by abandoning them. The regulations do not explain the steps that would constitute abandonment, but it seems reasonably clear that gifting or donating securities is not the same as abandonment: you have to give up all rights to the shares, including the right to determine who would enjoy the benefit if they somehow recovered value.

Note also that the regulations say abandonment itself doesn’t create the loss; instead, it merely establishes worthlessness. That means you’re still playing within the rules for worthless securities. The date of your loss is the last day of the taxable year in which the abandonment occurs, not the date of the abandonment. Also, you can’t claim an ordinary loss when abandoning a security if you would have a capital loss under the usual rules for worthless securities.

Claiming the loss

When you’re ready to claim the loss, you have to show it on Schedule D as a capital loss. (This assumes you don’t qualify for an ordinary loss on certain small business shares.) You can’t claim a theft loss, for example, on the theory that the stock became worthless because the executives were a bunch of crooks — even if that’s true.

The amount of the loss is determined by your basis for the shares. You may have seen the stock go sky high before it sank into oblivion, and that can leave you feeling like you lost a lot more than the amount you paid for the shares. You can’t include that unrealized profit in the amount of your deduction.

You have to report the loss as if you sold the shares for zero dollars on the last day of the taxable year. That’s true even if the event that establishes worthlessness occurs earlier in the year.

Statute of limitations

In a pinch, you can amend a prior year return to claim the loss. Recognizing the difficulty of determining which year to claim the deduction, Congress provided a special seven-year limitation period for reporting a loss from worthless securities — more than double the usual three-year period. If you’re just now realizing that some of your shares became worthless four or five years ago (or six or seven), you still have time to amend your return to claim the loss. The clock runs out seven years after the due date of the return for the year the stock became worthless.

Scroll to Top