You’re probably not in the business of purchasing stock in distressed companies. Before you buy a company’s stock, you make sure to conduct thorough research on its underlying financial strength and future growth prospects. Once you do pull the trigger and add it to your portfolio, you expect to reap the benefits of long-term stock ownership. These might include regular dividend payouts and a steady upward price trend.
Unfortunately, even the best-laid plans can go awry. When the unexpected occurs and a company whose stock you own declares bankruptcy, you’ll need to keep your cool and remember to report your losses in the proper manner.
Counting Pennies: What If a Stock Still Has Some Value?
When a troubled company files for Chapter 11 bankruptcy, which is also known as “bankruptcy reorganization,” investors tend to lose faith in its prospects and sell its stock en masse. This pushes its already-depressed stock price even closer to zero. With few remaining holders and even fewer interested buyers, some bankrupt companies trade for just a few pennies.
Your problem may be compounded by the IRS’s method of accounting for such “unrecognized losses.” Until a company has officially been liquidated in a Chapter 7 bankruptcy proceeding, its stock generally retains some value. Unfortunately, the IRS will refuse to recognize your losses on such stocks as long as they remain part of your portfolio. As such, you have two basic options for proceeding.
Your first option is simply to sell your nearly-worthless holdings. While distressed stocks tend to be less liquid than their healthy counterparts, your proposed sale should attract one or more bargain-hunting professional investors looking to profit from a miraculous turnaround. Once you unload your entire position, you’ll be able to claim the transaction as an investment loss on your next tax return and walk away from the situation with your dignity intact.
Your second option is to wait for the stock to become officially worthless and cease trading in all forms. This typically happens after a Chapter 7 bankruptcy obliterates all traces of a defunct company and the stock itself has no further reason to exist. Once your stock officially has no value, you can claim it as a “worthless transaction,” writing down its value as if you had given it away for free. However, this may increase your chances of being audited by the IRS.