8760 / When is a deduction permitted if a taxpayer owns securities that become worthless?

While IRC Section 166 does not apply to worthless securities,¹ IRC Section 165 allows a deduction for losses incurred based on ownership of securities that have become completely worthless during the year. The term “security” for purposes of IRC Section 165 includes shares of stock, stock rights or evidence of indebtedness issued by a corporation or a government.² The worthlessness of the security is a question of fact³ and the loss will be disallowed unless the taxpayer is able to furnish proof of the original cost of the security.⁴

There are no fixed rules that apply when determining whether a security is completely worthless. The taxpayer is required to make a reasonable inquiry, and what is reasonable here is based on the inquiry that a reasonable person would make in order to determine the worthlessness of the securities.⁵ Worthlessness must be determined objectively.⁶

The securities do not have to be sold to establish worthlessness,⁷ but it is insufficient to show that the securities would have no value if sold.⁸ Diminution in value is also not enough to establish worthlessness.⁹