Worthless Securities: Claiming the Loss and Ordinary Loss Exceptions

The tax treatment of worthless securities lets you deduct the full cost basis of a stock, bond, or similar instrument in the year it loses every last bit of value, treated as though you sold it on December 31 of that year. For most investors the result is a capital loss capped at $3,000 per year against ordinary income, with any excess carrying forward indefinitely. A few narrow exceptions convert the loss into a fully deductible ordinary loss.

What “Worthless” Actually Means

The tax code defines a security here as a share of stock, a right to receive stock, or a bond or similar debt instrument issued by a corporation or government entity in registered form or with interest coupons.¹ To deduct it as worthless, the security has to be entirely without value. A steep drop is not enough, even a 99% collapse, if the company still has assets, operations, or a realistic shot at recovery.

Treasury regulations draw the line hard. No deduction is allowed “solely on account of a decline in the value of stock” from market fluctuations or similar causes. A stock with any recognizable value on the date you claim the loss does not qualify, no matter how far it has fallen.²

This is where investors most often trip up. Partial-worthlessness deductions exist for certain business bad debts, but not for securities. With securities it is all or nothing: totally worthless and deductible, or partially worthless and not deductible.

When To Claim the Loss

When a security becomes worthless, the tax code creates a legal fiction: the loss is treated as though you sold the security on the last day of that tax year.³ Two consequences follow from that fictional December 31 sale date.

First, your holding period runs from the date you acquired the security through December 31 of the year it became worthless. A stock purchased in March 2025 that becomes worthless in August 2025 is treated as sold on December 31, 2025, giving you a holding period of about nine months, so a short-term loss. The same stock bought in March 2024 and worthless in August 2025 exceeds one year, making the loss long-term. Short-term losses first offset short-term gains (taxed at ordinary rates); long-term losses first offset long-term gains (taxed at preferential rates).

Second, the deduction belongs to the specific tax year in which worthlessness occurred. You cannot pick a more convenient year. Claim it in the wrong one and the IRS can disallow it on timing grounds alone.

The Seven-Year Amendment Window

Pinpointing the exact year is hard, and it is where most disputes arise. A company might stop operating in one year, enter bankruptcy in another, and receive a final liquidation order in a third. Congress built in a safety valve: for worthless securities, the normal three-year window to file an amended return and claim a refund is extended to seven years from the original filing deadline for the year of worthlessness.⁴ If you realize in 2026 that a security actually became worthless in 2020, you can still file Form 1040-X for 2020 as long as you are within seven years of that return’s original due date.⁵

If you are unsure which year the final event occurred, claim the deduction in the earliest year you can defend and be ready to amend if the IRS disagrees on timing.

Capital Loss Treatment for Most Investors

The default treatment for a worthless security held as an investment is a capital loss, because the statute treats worthlessness as a sale of a capital asset on December 31.³

Capital losses first offset any capital gains you realized that year. After netting against gains, you can deduct up to $3,000 of remaining capital loss against ordinary income ($1,500 if you are married filing separately).⁶ Anything above that carries forward indefinitely, subject to the same annual limit each year.

For a large loss with no offsetting gains, the $3,000 cap means the deduction can take many years to absorb. A $60,000 loss with no gains takes 20 years to use up. That is why the ordinary loss exceptions below matter so much when they apply.

Selling for a Nominal Amount

If a security still trades but at a tiny price, selling on the open market for even a few cents can be simpler than proving worthlessness later. A sale locks in a definite date, eliminates any timing dispute, and generates a clear capital loss on your brokerage statement. The trade-off is that you give up any chance of a future recovery.⁷

Abandonment as an Alternative

Since 2008, the IRS has recognized that abandoning a security can trigger a deductible loss under Section 165. To abandon a security you must permanently give up all rights in it and receive nothing in exchange.⁸ You cannot sell or transfer it to anyone, even for a symbolic price.

This can be useful when a security has clearly lost value but you cannot point to a single event proving worthlessness. The IRS weighs all facts and circumstances to see whether the transaction is a genuine abandonment rather than a disguised sale, gift, or capital contribution. If the abandoned security is a capital asset, the loss is still treated as a capital loss on the last day of the tax year, the same as worthlessness.⁸ Document it: a letter to the transfer agent surrendering your shares, a written notation in your records, or similar evidence showing you permanently relinquished ownership.

Ordinary Loss Exceptions

Capital loss treatment is the default. Three exceptions convert the loss into an ordinary loss, fully deductible against wages and other ordinary income with no $3,000 cap.

Section 1244 Small Business Stock

Section 1244 was written to encourage investment in small domestic companies. If stock qualifies, an individual can treat up to $50,000 of the loss as ordinary per year, or $100,000 on a joint return. Anything above that cap reverts to a capital loss.⁹

To qualify, the stock must have met several conditions when it was issued:

The issuer was a domestic corporation, and the total money and property it received for all its stock, capital contributions, and paid-in surplus did not exceed $1,000,000.
The stock was issued for money or property. Stock received for services or in exchange for other stock and securities does not qualify.
During the five most recent tax years before the loss, more than 50% of the corporation’s gross receipts came from active business operations rather than passive sources like royalties, rents, dividends, or investment gains.⁹

Only the original purchaser can claim ordinary loss treatment. Inherited stock, gifted stock, or shares bought on the secondary market from the original holder do not qualify, and the loss reverts to a capital loss.¹⁰

The corporation does not file anything with the IRS to designate the stock as 1244 stock. It qualifies automatically if the requirements are met. But you, the shareholder, need records to prove those requirements years later: the stock purchase agreement, corporate financial statements showing the $1,000,000 capitalization limit was not exceeded, and gross receipts records showing the active business test was satisfied.¹¹

Securities in Affiliated Corporations

A separate exception applies mainly to corporate taxpayers that own stock in a subsidiary. When the subsidiary’s stock becomes worthless, the parent can claim an ordinary loss if two tests are met.³

The parent directly owns stock representing at least 80% of the subsidiary’s total voting power and at least 80% of the total value of all classes of the subsidiary’s stock.¹²
More than 90% of the subsidiary’s total gross receipts across all its tax years came from active business operations. Passive income (royalties, most rents, dividends, interest, annuities, and gains from selling stocks or securities) does not count toward the 90%.

The 90% test looks at the subsidiary’s entire history, not just recent years. A company that spent its early years as a holding entity before pivoting to active operations may not clear the bar. Both tests have to be satisfied.

Small Business Investment Company Stock

A less common exception covers stock in a Small Business Investment Company (SBIC) licensed under the Small Business Investment Act of 1958. A loss on SBIC stock that would otherwise be a capital loss is treated as an ordinary loss.¹³ Unlike Section 1244, there is no dollar cap. The loss is also treated as attributable to a trade or business, which means it can feed a net operating loss that carries into other years.

Proving Worthlessness

The burden of proof is on you. You have to show two things: the security had some value at the start of the year you are claiming, and a specific event during that year wiped out all remaining value.

Identifiable Events

The IRS and courts look for a concrete event that makes recovery impossible. Recognized examples include:

A final decree of bankruptcy with no distribution to shareholders
A formal corporate dissolution or liquidation
Complete cessation of all business operations with no assets remaining
Appointment of a receiver who confirms there are no assets for equity holders

Delisting alone does not prove worthlessness, because a company can still hold assets or trade over the counter. Bad earnings, a collapsed price, or your own pessimism are not enough either. The standard is finality.

Documentation To Keep

Bankruptcy court orders, especially any final distribution order confirming nothing went to equity holders
Corporate minutes or state filings showing formal dissolution
Financial statements showing liabilities exceeded assets with no prospect of reversal
Correspondence from a trustee, receiver, or liquidator confirming no distribution to shareholders
Evidence of delisting and the absence of any secondary market (supporting, not sufficient)

Reporting the Loss

Report the worthless security on Form 8949. Enter the last day of the tax year as the sale date and $0 as the sale price. Your cost basis is what you originally paid, adjusted for any returns of capital along the way. Totals from Form 8949 flow to Schedule D of Form 1040, where gains and losses are netted.¹⁴ For an ordinary loss under Section 1244, attach documentation showing the stock met the qualification requirements when it was issued.

Cryptocurrency and Other Digital Assets

The rules above do not cover crypto in the same way. The IRS treats digital assets as property, not as securities under Section 165(g).¹⁵ If you sell a digital asset for any amount, even pennies, the loss is a straightforward capital loss reported like any other sale. Where a token has become truly worthless with no market, the IRS in Chief Counsel Advice 202302011 rejected a Section 165 deduction for cryptocurrency that had merely declined in value: the crypto was not worthless, had not been abandoned, and could still increase in value.

For the 2018 through 2025 tax years, losses on worthless or abandoned digital assets held as personal investments were classified as miscellaneous itemized deductions, which the Tax Cuts and Jobs Act suspended. That suspension is scheduled to expire starting in 2026, though Congress may extend it, and IRS guidance remains limited. Where possible, the cleaner move is to sell a worthless token for any amount and generate a clear capital loss rather than rely on the worthlessness or abandonment rules.

1
Office of the Law Revision Counsel. 26 USC 165 – Losses
2
GovInfo. 26 CFR 1.165-5 – Worthless Securities
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Office of the Law Revision Counsel. 26 USC 165 – Losses
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Office of the Law Revision Counsel. 26 USC 6511 – Limitations on Credit or Refund
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Internal Revenue Service. File an Amended Return
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Internal Revenue Service. Topic No. 409, Capital Gains and Losses
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Internal Revenue Service. Losses – Homes, Stocks, Other Property
8
Federal Register. Abandonment of Stock or Other Securities
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Office of the Law Revision Counsel. 26 USC 1244 – Losses on Small Business Stock
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eCFR. 26 CFR 1.1244(a)-1 – Loss on Small Business Stock Treated as Ordinary Loss
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eCFR. 26 CFR 1.1244(e)-1 – Records To Be Kept
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Office of the Law Revision Counsel. 26 USC 1504 – Definitions
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Office of the Law Revision Counsel. 26 USC 1242 – Losses on Small Business Investment Company Stock
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Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets
15
Internal Revenue Service. Digital Assets