Do you own stock in a company whose shares dropped sharply in value or even became worthless after you purchased them? You may be tempted to simply put it behind you, but it’s important to remember that you can claim a capital loss deduction on your next tax return.
Here’s what you need to know about the rules that come into play when a stock you own is sold at a loss or loses all of its value.
Capital losses produced by stock sales
Whenever you sell stocks, they become either capital gains or capital losses. When filing your taxes, any capital gains and losses must be netted against each other based on whether they’re short-term (owned for one year or less) or long-term (owned for one year or more).
If you have short-term or long-term losses (or both) after netting, you can use these losses to offset a maximum of $3,000 of income or $1,500 for married taxpayers who choose to file separately. Any loss you incur over this limit carries over to later years until the entire amount is offset against capital gains or deducted against ordinary income. If both partners have net short-term and net long-term losses, the short-term losses will offset income before the long-term losses are utilized.
If you’ve earned capital gains during the year from selling stock or other assets, it may be wise to consider selling a portion of your losing assets to offset the cost of these gains. Selling enough of your losing assets to cover earlier gains and create a $3,000 loss is an excellent strategy for saving money when you file taxes.
Understanding the wash sale rule
You may want to sell a stock now to lock in a tax loss even if you believe the stock will recover in the future. According to the wash sale rule, if you sell a stock at a loss and repurchase identical stock within 30 days of your sale date, you cannot claim your loss when you file your taxes.
What to do with worthless stock
If you own a stock that has become completely worthless, you can claim a loss equal to your basis in the stock. This amount is typically what was initially paid for the stock and is treated as though you’ve sold on the last day of the tax year, which is essential to note as this date decides if your loss is categorized as short-term or long-term.
When stocks have no liquidation value, they become worthless—this is due to the corporation that issued the stock having liabilities that outweigh its assets and no reasonable chance of becoming profitable in the future. A stock can still be worthless even if a corporation hasn’t declared bankruptcy. On the other hand, some stocks may still have value after a corporation has filed for bankruptcy, provided that the company is still operating.
If you discover that a stock you owned has become worthless only after you’ve filed your tax return for the year, you can amend your return to claim a credit or refund because of the loss. You can make this claim within seven years of your original return being due or two years from the date you paid.
Dealing with special circumstances when claiming losses
If you’ve been the victim of an investing scam like a Ponzi scheme, you may be able to reduce your losses by availing yourself of special tax relief provided for situations like these.
Trust your tax questions to Smolin
If you’re unsure how to claim your losses this tax season or need assistance with filing, the CPAs at Smolin can help. Contact us for more information about claiming losses on depreciated or worthless stocks.