Understanding Worthless Securities: Definition, Summary, Frequently Asked Questions

Securities that hold no market value, known as worthless securities, can lead to a capital loss for investors. These securities, which may have been abandoned by the investor, can be claimed as such when filing taxes.

What Are Worthless Securities?

Worthless securities encompass stocks or bonds, whether publicly traded or privately held. The IRS advises treating these securities as if they were sold or exchanged as capital assets on the last day of the tax year to declare a capital loss. Determining the holding period is crucial to categorize the loss as short-term (under one year) or long-term (over one year).

Short-term losses are reported on Part I of Schedule D, allowing investors to offset gains against losses for a net result.

Long-term losses are reported on Part II of Schedule D, where investors can similarly match gains with losses for a final calculation of net gains or losses after separately recording these in Parts I and II.

Utilizing a strategy called tax selling, investors may leverage worthless securities to offset capital gains from other investments.

Understanding Worthless Securities

The market value of publicly traded companies, or market capitalization, is determined by multiplying the current share price by the outstanding shares. In contrast, private company valuations can be based on methods like comparable company analysis or discounted cash flow estimations. Worthless securities hold a value of zero, signifying their lack of market worth.

For a security to be deemed worthless, it must not only lack current value but also lack potential for future value. Market fluctuations can reduce a stock to zero, but if there’s a chance for recovery, it isn’t considered worthless. Conversely, stocks from companies that have ceased operations after going bankrupt are likely worthless.

Worthless Stocks vs. Penny Stocks

While worthless stocks have zero market value, penny stocks typically trade below $5. Despite their low value, penny stocks carry the risk of becoming worthless securities due to their speculative nature. Traded outside major exchanges, these stocks are considered high risk with limited liquidity and small capitalizations.

Some examples of penny stocks include companies like Wrap Technologies, Inc. (WRAP) and Smith Micro Software, Inc. (SMSI).

How Do I Report Worthless Securities?

If you possess a worthless security, complete IRS Form 8949 and provide details on its purchase and sale dates, as well as the amounts involved.

When Can You Claim a Worthless Stock?

Claim a worthless stock in the tax year it becomes valueless.

How Are Worthless Securities Taxed?

Worthless securities are taxed as capital losses, allowing for a deduction in the year when the security is deemed worthless.