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Julie M. Sturgeon: How to get a tax deduction for worthless stock

It’s Your Money

Posted: January 13, 2010 9:03 p.m.
Updated: January 14, 2010 4:55 a.m.
 
You know a number of businesses in different industries such as financial firms, car manufacturers and clothing/retailers went through bankruptcy proceedings last year - events that are painful to remember if you owned stock in a now-defunct company.

Once the investment is worthless (even if a stock has no value on a securities exchange), you may still get some benefit in the form of a tax deduction.

When you own securities such as stocks, stock rights or bonds that become completely worthless, you can claim a capital loss on your tax return. You report the loss in the year the investment loses all value, using the last day of the year as the disposal date no matter when the stock stopped trading.

The date is important because it affects whether you have a short- or long-term capital loss.

An example is if you owned common stock in a company that finalized bankruptcy proceedings last July. You include the loss on your 2009 return, with Dec. 31 as the date of disposal.

What if you just realized a stock became worthless in a prior year, but you forgot to claim the loss? Under a special rule, you generally have up to seven years from the due date of your original return to file for a refund.

Determining when a stock is completely worthless is not always as clear-cut. Alternative methods including a sale to your brokerage firm or abandonment of the investment can also secure the loss.

Review your portfolio to make sure you can qualify to take a deduction for losses on your 2009 return. But if you plan on buying back the stock with hope it will revive, be careful of the wash-sale rules.

If you are eyeing your portfolio with year-end investment loss harvesting in mind, take a moment to analyze the timing.

A section of the Internal Revenue Code that prevents you from claiming a current loss on certain investments you sell, then reacquire within a short time period, pertains to wash sales.

Per the IRS code: "A wash sale occurs when you sell stock or securities at a loss and within 30 days before or after the sale you buy or acquire in a fully taxable trade, or acquire a contract or option to buy, substantially identical stock or securities. If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale. You add the disallowed loss to the basis of the new stock or security."

In addition to the 30 days before you sell the investment and the 30 days after, the wash sale rules include the day of the sale.

The rules apply to losses generated by transactions involving "substantially identical" stocks and securities, including mutual funds and stock or option grants you receive as part of your compensation.

Whether one security is considered substantially identical to another depends on several factors. Generally, stocks or bonds in different companies - even those in the same industry - are not substantially identical.

Wash sales can occur when you repurchase the security in your IRA, or when your spouse or a company you control does the buying.

While wash sale rules defer capital losses, in most cases you'll eventually get the benefit since the disallowed loss is added to the basis of the reacquired securities.

The holding period of the original security is also carried over, creating planning opportunities.

Julie M. Sturgeon is a certified public accountant in Valencia specializing in individual and business tax issues. Her column represents her own views and not necessarily those of The Signal. "It's Your Money" appears Thursdays and rotates between a handful of the valley's financial professionals.

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