Worthless securities are any securities that have reached a point where the value attributed to the investment is zero. Both shares of various stock offerings and a wide range of bond issues may be declared worthless under certain circumstances. When any security reaches this point of zero worth, this results in a capital loss for the owner that can partially be offset with the declaration of a tax deduction when filing the annual tax return.
Depending on the laws and regulations that are put in place by the relevant tax agency, the process for identifying securities as worthless may be relatively easy, or a somewhat complicated process. Some agencies require that the market value of the worthless securities remain at zero for at least five or six consecutive months before they can be claimed as a capital loss. Other agencies require nothing more than documented proof supplied by a reputable brokerage house or a representative of the exchange where the securities were traded. Because the criteria for identifying worthless securities varies, it is important to understand what regulations and procedures are required by the state or national tax agency where the investor resides.
One approach to declaring a loss on worthless securities is to sell the now worthless shares or bond issues to a third party at what is obviously a deep loss to the investor. While the sale does create an immediately documented loss that is likely to satisfy the requirements of most tax agencies, the potential to finding anyone who wants to purchase worthless shares is somewhat low, even among investors who are looking to create some sort of capital loss for themselves. A more likely strategy is identifying a specific event that occurred to render the securities of no value, and then demonstrate that the securities never recovered from the outcome of that event. While more painstaking in terms of documenting the circumstances, the effort usually results in the ability to claim a higher capital loss when filing the tax return for the period where the loss occurred.
It is important to make sure worthless securities are indeed totally worthless before attempting to use them to declare any type of capital loss. In the event that the apparently worthless shares or bonds remain in the possession of the investor, and they rally for some reason during the next tax period, it may be necessary to file an amended tax return for the year where the securities were claimed to be worthless. Depending on the amount of the capital loss declared, this could result in owing a sizable amount of back taxes, as well as incurring tax penalties.