Tip: Cash in loss deductions for worthless stock

After last year’s stock market debacle, you could be holding assets worth a fraction of their original cost. In fact, some stocks may have zero value.

Strategy: Claim a capital loss deduction for worthless stock on Schedule D of your ’08 return. The loss can offset capital gains plus up to $3,000 of high-taxed ordinary income.

However, you must be able to establish that the stock is truly “worthless.” Timing in this area can be critical.

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Here’s the whole story: To claim a 2008 deduction for worthless stock, you must be able to show that the stock had value before 2008 and that an identifiable event caused its value to drop to zero last year. A steep decline in the value of the stock, by itself, isn’t sufficient. The stock must have no recognizable value.

A worthless stock is treated as if it had been sold on the last day of the tax year. Thus, the resulting loss is either short-term or long-term for stock held longer than one year.  

You can claim the loss for worthless stock for the year it becomes worthless even if you sell it for a nominal amount the following year. If you can’t determine that the stock has become worthless until a subsequent year, file an amended return for the year it actually became worthless. Because this determination is often difficult to make, claim the loss in the earliest year it’s reasonable.

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If you currently own stock that is on the verge of becoming worthless, sell it now to realize a 2009 tax loss without having to show that the securities have become worthless. Caveat: Don’t sell the stock to a “related party” like a child or a corporation in which you own stock. If you do, the loss will be disallowed.

Finally, keep all relevant records in case the IRS ever challenges your loss deduction. This includes financial statements indicating the date on which the stock became worthless.

Tip: Usually, you have a three-year period to file an amended return. But this period is extended to seven years for losses relating to worthless stock.

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