- Worthless securities are stocks, bonds, or other holdings that have no market value; they can be publicly traded or held privately.
- The IRS recommends investors account for worthless securities as if they were capital assets that had been dumped or exchanged on the last day of the tax year.
- As such, these securities can be claimed as a capital loss when the investor files their taxes; the holding period determines whether the loss is short-term or long-term.
- Penny stocks have comparatively little market value but are not considered worthless, though they have the potential to become just that.
What Are Worthless Securities?
Worthless securities can include stocks or bonds that are either publicly traded or privately held. To declare a capital loss from worthless securities, the Internal Revenue Service (IRS) suggests investors treat them as if they were capital assets sold or exchanged on the final day of the tax year. As with other securities, investors must first figure out the holding period to determine if the capital loss is short-term (one year or less) or long-term (greater than one year).
In the case of a short-term loss, investors must report this on Part I of Schedule D. Investors can net short-term gains and losses against one other to determine a net short-term gain or loss.
For long-term losses, investors report these in Part II of Schedule D. Again, investors can net long-term gains and losses against each other to determine the net long-term gain or loss. After the investor completes these calculations separately in Parts I and II of Schedule D, they can net them together for an overall result.
You may be able to use a worthless security in a tax strategy called tax selling, where an investor sells an asset with a capital loss in order to lower or eliminate the capital gain that they realize via other investments.
Understanding Worthless Securities
Public company market value, also known as market capitalization, is the number of outstanding shares of a publicly-traded company, multiplied by the current share price. For a private company, valuation methods include comparable company analysis or an estimation of discounted cash flows. Worthless securities will have a market value of zero as noted above.
For a security to become worthless, it not only needs to have no value, but it needs to have no potential to regain value. For example, a company's stock might reduce in value to zero if the market fluctuates enough. If the company has a chance to regain ground in the market, it would not be worthless stock. However, if the company closed its doors after bankruptcy, its stock would likely be worthless.
Worthless Stocks vs. Penny Stocks
Worthless stocks have a market value of zero, while penny stocks generally have market values of less than $5. However, penny stocks have the potential to become worthless securities. Because of their small market value, penny stocks typically trade outside the major market exchanges (through the OTC Markets Group and pink sheets) at a relatively low price ($5 or less). These stocks are considered highly speculative and high risk due to their lack of liquidity, large bid-ask spreads, small capitalizations, and limited followings and disclosures.
Some examples of penny stocks are:
- Wrap Technologies, Inc. (WRAP)
- LiqTech International, Inc. (LIQT)
- Smith Micro Software, Inc. (SMSI)
- Red Cat Holdings, Inc. (RCAT)
- VIA optronics AG (VIAO)
- National CineMedia, Inc. (NCMI)
How Do I Report Worthless Securities?
If you have a worthless security, you'll need to file IRS Form 8949. Make sure you have the dates you purchased it, the date you sold it, and the amount you paid and received available.
When Can You Claim a Worthless Stock?
You can claim a worthless stock in the tax year in which it becomes worthless.
How Are Worthless Securities Taxed?
They are taxed as a capital loss and can be claimed in the year the security becomes worthless.