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Cashing In on Those Worthless Shares
By Tracy Byrnes
TheStreet.com Contributor
2/23/2005 7:04 AM EST
Click here for more stories by Tracy Byrnes
When WorldCom emerged from bankruptcy in April 2004, shareholders found out that their securities were worthless. With the new company -- MCI (MCIP:Nasdaq - commentary - research) -- came a new security.
Thank goodness.
After all the angst the company put them through, shareholders now at least could declare a capital loss on their 2004 tax returns and be done with the whole mess.
Unfortunately, we can't say the same for Enron shareholders. The company is still holding on for dear life. And while those shares no longer do anything positive for your portfolio, Uncle Sam will not let you call them "worthless" and declare a capital loss.
"A lot of people think that just because the stock is junk, they can write it off. Well you can't do that," says Jackie Perlman, a senior tax research analyst at H&R Block.
As long as the company is alive in some, albeit pathetic, form, the IRS does not consider the stock worthless.
That's because there's always the chance that a company can come back from, what appears to be, the dead. Look at Mattel (MAT:NYSE - commentary - research) in the early 1980s, says Perlman. The company was caught with phony sales and the stock plunged. Everyone presumed the company best known for its Barbie doll had dug its own grave. But it bounced back.
Filing for bankruptcy protection isn't even a surefire bet that your shares will be considered worthless either.
WorldCom filed a record $104 billion Chapter 11 reorganization back in July 2002 after an accounting scandal and the shares were not considered worthless at that point.
"That's because a Chapter 11 reorganization means there still may be something there," says Perlman. It allows businesses to reorganize themselves and gives them an opportunity to restructure debt and get out from under certain leases and contracts. And with a Chapter 11 reorganization, the company generally gets to keep its doors open for business.
If, on the other hand, it files for a Chapter 7 bankruptcy, then everything is fully liquidated and the doors are generally shut. In that instance, your stock is probably worthless. Hopefully you'll receive a letter from the bankruptcy court telling you that if you try to sell those shares you won't get a penny for them, says Mark Luscombe, a principal federal tax analyst with CCH Inc., a provider of tax and business law information.
If you don't receive written confirmation, do some legwork yourself. Look at the company's balance sheet in the financial statements. If the liabilities of the corporation are much greater than its assets, and profit is far from sight, then the stock is probably worthless.
When in doubt, check out the investor relations section of the company's Web site or call your broker to confirm. Be sure to get written documentation stating the stock is worthless.
Take That Loss and Run
Once you've proven that the stock is worthless, you can report the loss on your tax return in the year the shares are declared worthless.
Remember, as crazy as this may sound, losses are actually good things in the tax world. Capital losses will offset any capital gains you have on your tax return and thereby decrease your tax bill. Let's assume you sold some shares last year and walked away with a $5,000 gain. Assuming you've held those shares for more than a year, you'll owe 15% long-term capital gains tax on that amount. If you now can report a $3,000 loss from your worthless securities, you will bring your net gain down to $2,000. Now that's the amount you'll be taxed on.
Worthless securities are treated as though they were sold on the last day of the tax year. So report them on Schedule D -- Capital Gains and Losses, either on line 1, if you held the shares for a year or less, or line 8, if you held them longer. In columns (c) and (d), write "Worthless" instead of filling in a date sold or a sale price. Your loss will be the difference between what you originally paid for the shares and zero.
What Are Friends For?
If your shares are not worthless and are trading for a few pennies, odds are good no one is going to want to buy them, so you can close the trade and declare the loss. So you have some choices. You can just hold on to them and hope the company comes back so you can recoup some of your money.
Or you can consider selling those loser shares to a friend. That's right. If you can convince your friend to pay fair market value for your shares -- i.e., a dime -- then you can take the loss on your tax return.
First you'll need to find the actual stock certificates because you'll have to be able to hand those over. So call your broker if you don't have them.
Then properly sell the shares. That means write up a bill of sale and have your friend write you a check for the payment so you have a paper trail.
Then just send the certificates to the stock transfer agent to complete the sale. Explain that the shares have been sold, and ask the agent to cancel the old shares and issue a new certificate to the new owner.
The upside is you now have a closed sale and you can take the capital loss. Even better, you didn't have to pay a brokerage fee (which would've probably cost more than the whole deal) to get rid of those worthless shares.
Hey, what are friends for if you can't sell them your useless stock?
The IRS' Publication 550 discusses worthless securities, although it doesn't offer much help.
So before you get stuck with them, consider selling your questionable shares while you can still find a friendly sucker to buy them. |
