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The value of your stock when a company declares bankruptcy

Posted by Andrew Chan  June 1, 2009 10:00 AM

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I own GM stock. If the company goes bankrupt can I claim a loss on my income taxes or do I have to sell it now for pennies to claim that loss?

In order to take a tax deduction for a worthless security without having to sell first, the security must be considered entirely worthless. A company's stock does not necessarily become entirely worthless if they file for bankruptcy. Under Federal bankruptcy laws a company can file for Chapter 7 or Chapter 11 bankruptcy. If a company files under Chapter 7, it means that the company ceases to operate and goes out of business. The company's assets will be sold and the proceeds generated from that liquidation will be used to pay back the company's creditors and investors. If the company files under Chapter 11, which is what GM is expected to do today, it means that the company continues to operate on a daily basis and tries to reorganize its business with the goal of eventually emerging from bankruptcy as a profitable company.

A company's stock may continue to have value and trade on a public stock exchange even though it is in bankruptcy. Stocks that do not meet the requirements to be listed (and thus traded) on one of the major exchanges like the NYSE or the NASDAQ, may trade on other public exchanges like the OTC or the Pink Sheets. Generally, if the company's stock retains some value the only way to capture the loss and receive a tax deduction is to sell the stock and record the capital loss based on the cost basis of the shares you sold.

If stockholders do not receive any value for the shares they own and the stock loses all of its value (i.e., is deemed worthless) as a result of the bankruptcy, the stockholder may be able to take a tax deduction for any losses incurred when the stock became worthless. In this case, the stockholder would not necessarily need to sell the stock to have it considered worthless.

One thing to keep in mind is that even if a company emerges from bankruptcy as a viable business, the value of the company's stock held by investors prior to the bankruptcy may be deemed worthless. This often occurs as part of a company's reorganization plan if the existing common stock is canceled and new shares are issued after the company emerges from bankruptcy. Secured and unsecured creditors, such as bond holders, usually receive some of the new shares of stock as repayment of the company’s debts. Stockholders usually don’t receive any repayment until the secured and unsecured creditors are repaid in full.

For more information about how to determine if your security is worthless (for purposes of the IRS) visit the IRS web site at http://www.irs.gov/publications/p550/ch04.html#en_US_publink100010315

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
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