Worthless Securities
Worthless securities are stocks, bonds, or other holdings that have no market value and no realistic potential to regain value. When a security is truly worthless — including securities an investor has abandoned — it results in a capital loss that can be claimed on taxes in the year it becomes worthless.
Key takeaways
- Worthless securities have a market value of zero and can be either publicly traded or privately held.
- For tax purposes, the security is generally treated as if it were sold or exchanged on the last day of the tax year in which it became worthless.
- The holding period determines whether the loss is short-term (one year or less) or long-term (more than one year).
- Report the loss on IRS Form 8949 and carry the totals to Schedule D (Part I for short-term, Part II for long-term).
- Penny stocks usually trade for $5 or less and are not automatically worthless, but they are high-risk and can become worthless.
What makes a security worthless?
A security is worthless when it has a market value of zero and no reasonable possibility of regaining value. Examples include:
* A public company that has been liquidated or whose equity is senior to all remaining claims after bankruptcy proceedings.
A private company that has ceased operations and has no residual assets.
Securities that have been abandoned by the owner with no expectation of recovery.
Market value differs by entity type:
Public companies: market capitalization = outstanding shares × current share price. A share price of zero implies no market value.
Private companies: valuation requires methods such as comparable analysis or discounted cash flow estimates; a zero value means no expected future benefit.
Worthless securities vs. penny stocks
- Worthless securities: market value is zero and recovery is not reasonably expected.
- Penny stocks: typically trade at $5 or less, often off major exchanges (OTC markets, pink sheets). They are highly speculative and risky due to low liquidity, wide bid-ask spreads, small capitalization, and limited disclosure. Penny stocks can become worthless, but low price alone does not make them worthless.
Examples of penny-stock companies (illustrative): WRAP, LIQT, SMSI, RCAT, VIAO, NCMI.
Tax treatment and reporting
- Determine the year the security became worthless. You may generally claim the loss in that tax year.
- Treat the security as if sold or exchanged on the last day of that tax year for tax purposes.
- Complete IRS Form 8949 with the purchase date, date sold (use Dec 31 of the tax year if treated as sold then), cost basis, and proceeds (zero).
- Transfer totals from Form 8949 to Schedule D:
- Part I — report short-term gains and losses (held one year or less).
- Part II — report long-term gains and losses (held more than one year).
- Net short-term and long-term results separately, then combine to get the overall capital gain or loss.
- Losses from worthless securities are capital losses and may offset capital gains; excess capital losses can generally offset up to a limited amount of ordinary income per year and be carried forward according to tax rules.
Practical considerations
- Recordkeeping: retain purchase records, correspondence, bankruptcy filings, liquidation notices, or other documentation that supports the security’s worthlessness.
- Abandoned securities: if you abandon a security and can demonstrate intent to abandon with supporting evidence, it may be treated as worthless for the year of abandonment.
- Tax strategies: investors sometimes use tax-loss harvesting (selling assets with losses) to offset gains. Worthless securities effectively realize a capital loss for this purpose.
- Seek professional advice: determining worthlessness and correctly reporting losses can be complex, especially for private-company securities or amid bankruptcy proceedings.
When and how are worthless securities taxed?
They are not taxed as income; instead, they produce a capital loss. Claim the loss in the tax year the security becomes worthless and report it as described above.