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Check Your Portfolio for Losses You Should Take
Double-check for any capital losses you are entitled to for worthless securities


The IRS generally permits you to take a capital loss for stocks or securities that become worthless during the year.  However, the IRS rule is tough—the stock or security must be "wholly worthless"—and this means that there can be no chance of any recovery.  Thus, there is no deduction if your investment becomes partially worthless.  And, the taxpayer has the burden of proof and must be able to demonstrate to the IRS that the stock or security is worthless.  So given these hurdles, how can an investor take advantage? 

One problem that an investor faces is that once a stock or security is de-listed and is no longer publicly traded, it can be practically impossible to determine whether its value has gone to zero.  And, issuers and corporate actions advisers rarely inform holders if a stock or security is worthless under the IRS standard.  Thus, an investor may have a difficult time meeting the burden of showing that a stock or security is wholly worthless. 

Another problem is that the IRS rule only permits the loss during the year the stock or security becomes worthless.  In other words, if a stock became worthless in 2005, you can't take the loss in 2006.  Instead, you'd have to go back and amend your 2005 tax return to take the loss. 

Thus, an investor must be concerned about two things—proof of worthlessness and taking the loss in the proper year.  In preparing your tax return, you should review your portfolio to check if any of your holdings appear worthless.  Have any of your holdings de-listed?  Has the issuer of any stock or security you hold filed bankruptcy?  If so, it may be worthwhile to do some further research to see if you can demonstrate worthlessness during 2006.  If you can, you should generally be entitled to a capital loss equal to your basis in the stock or security.  The stock or security is treated as sold on the last day of the year for purposes of determining whether the loss is long-term or short-term and you report the loss on schedule D and write "worthless" in the entry.  What can you do if you discover that you hold de-listed or bankrupt issuer stock or securities that you can't prove are wholly worthless?  You can sidestep this issue by having your broker purchase them from you as a courtesy for a nominal amount of money, such as a penny (note that your broker may charge you a commission).  Because this would constitute a sale or exchange, you would be entitled to compute gain or loss and take a capital loss based on the difference between your tax basis and the proceeds received (for example, a penny).  Of course, the loss would be recognized in the year of the sale (2007).  This is just one more reason to review your portfolio before year-end.


DISCLAIMER: The information and views set forth in GainsKeeper Tax Topics are general in nature and are not intended as legal, tax, or professional advice. Although based on the law and information available as of the date of publication, general assumptions have been made by GainsKeeper Tax Topics which may not take into account potentially important considerations to specific taxpayers. Therefore, the views and information presented by GainsKeeper Tax Topics may not be appropriate for you. Readers must also independently analyze and consider the consequences of subsequent developments and/or other events. Readers must always make their own determinations in light of their specific circumstances.