In 2023, we saw one of the highest rates of corporate bankruptcy filings in over a decade. Fortunately, investors wishing to soften the blow of lost investments may be entitled to tax write offs. However, the IRS tends to scrutinize tax write offs carefully. It is important to consider if the investment is completely worthless and when the investment became worthless. We can help you determine whether and when to claim the losses on your tax returns.

Defining “Worth”…or Lack Thereof

Securities are considered worthless if their respective companies are no longer operating. Current tax laws state that there must be no chance that you will receive any return from your investments in said stocks. For example, stocks sold by a company filing for bankruptcy may not necessarily qualify as worthless, especially if the company is still operating. If the company is operational, your stock may yet regain value.

We strongly advise our clients to keep documentation that proves that the companies that issued the “worthless” stock are in fact non-operational. Clients should keep these records to avoid objection by the IRS. Worthless securities should be written off in the year that they were rendered worthless. These securities should also have a transaction date of 12/31 of that same year.

Once an investment has been determined to be worthless, the resulting loss will generally be a capital loss, which can be utilized to offset capital gains. If your net capital losses exceed your capital gains, you may only utilize a maximum of $3,000 of these losses against other types of income.

Section 1244 Stock

We also encourage our clients to take advantage of stock losses as defined under Section 1244 of the tax code. As stipulated in Section 1244, sales or dispositions of stocks related to small domestic corporations may qualify as ordinary losses rather than capital losses. In order to qualify for the ordinary loss treatment, the following must be true:

  • The corporation issuing the stock is considered a small business corporation where the money or property received as capital contributed is not greater than $1 million when the stock is issued.
  • The entity purchasing the stock must be an individual or a partnership. In order to qualify, the stock cannot be purchased from a third party. Stocks distributed by the partnership will not qualify for the ordinary loss.
  • The stock must be purchased with money or property (not with other stocks or securities).
  • 50% of gross receipts from the previous five tax years must be derived from sources not including: rents, royalties, dividends, interest, annuities, and gains from sales and exchanges of stocks or securities. Other rules must be met if the corporation is younger than five years.

The taxpayer is responsible for keeping records proving that the stock qualifies for ordinary treatment.

If all of the above criteria are met, the taxpayer can benefit from an ordinary loss up to the amount of the loss so long as that loss does not exceed $100,000 per year (for taxpayers filing under the married filing jointly status). When calculating a Net Operating Loss (NOL), keep in mind that current tax law allows taxpayers to treat ordinary losses as business losses.

Do Your Stocks Qualify?

If you have any worthless stocks, we may be able to help you take advantage of major tax savings opportunities. Even if your stock may not meet all the requirements to write off as a worthless loss, there may be other ways to realize a loss on your investment such as selling to an unrelated party in an arms-length transaction. Your accountants at Realize are happy to help you evaluate your assets to determine whether or not your securities qualify to be written off as worthless or if there might be other avenues available to take a loss on your securities.

Realize Your Business Goals

Every business, from start-ups to seasoned operations, needs a proactive trusted advisor working for its best interest. Whether your business is technology, venture capital or real estate, Realize can ensure your accounting and tax compliance needs are met. We provide your company with meaningful business advice and make certain you are taking advantage of the tax saving opportunities available to you.