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

1. Determine the year the security became worthless. You may generally claim the loss in that tax year.
2. Treat the security as if sold or exchanged on the last day of that tax year for tax purposes.
3. 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).
4. Transfer totals from Form 8949 to Schedule D:
5. Part I — report short-term gains and losses (held one year or less).
6. Part II — report long-term gains and losses (held more than one year).
7. Net short-term and long-term results separately, then combine to get the overall capital gain or loss.
8. 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.