What happens to your cost basis if the company whose stock you own goes through a bankruptcy reorganization?
If it is a Chapter 11 filing, you may receive some stock or other securities in the reorganized corporation.
If it is a Chapter 7 filing for complete dissolution, you are eligible (but not likely) to receive any cash left over after all debt is paid off.
The general tax rule that applies is that you cannot recognize a capital loss until the security becomes completely worthless, with no prospects for any further recovery. Deductions for partial loss of value are not allowed. You must actually sell the stock or have the bankruptcy trustee declare it as worthless for you to be able to recognize the loss. If a stock in bankruptcy stops trading, it cannot be sold on a stock exchange and recognition of your loss is held up until the bankruptcy is resolved.
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The new securities that you receive after the reorganization usually have a cost basis carried over from your original stock. If you receive multiple securites, you allocate your cost basis according to the relative market values of the securities you received.
If the reorganization process extends over a long time frame, a liquidating trust may be created by the bankruptcy court to manage the process. The liquidating trust is a grantor trust which will have income and expenses for you to report on your individual income tax return. You may not know your total bankruptcy proceeds until the liquidating trust is dissolved. You may not be able to compute your correct cost basis for new securities received until the process is completely finished.
There are always exceptions to every general rule, so be sure to read any tax guidance information provided to you by the company for your particular stock. For instance, the Equity Warrants received by former common shareholders in the Genco Shipping & Trading bankruptcy were taxable and triggered recognition of a gain or loss instead of a carryover basis. Consult your own tax advisor for a full understanding of the bankruptcy's tax consequences to you.
The point in time that a security becomes worthless determines when a capital loss can be taken as well as when any suspended losses are released. This determination can be complex, especially if there is no bankruptcy trustee to provide a definitive answer. Here is a link to a Journal of Accountancy article that we recommend. It discusses the topic: When is a Stock Worthless?
If you don't expect a substantial recovery at the end of the long bankruptcy process, you may be able to shortcut the waiting time by selling your non-trading shares to an odd lot broker for a penny. This will cause the loss to be realized so that you can recognize it on your tax return. A broker can arrange this for you.
Information provided is intended solely for cash-basis U.S. citizen individual taxpayers and is believed to be accurate for most cases but is not guaranteed. Always consult your personal tax advisor about your own situation. Suggestions are most welcome. Please email our webmaster @ costbasis.com with your comments. If this website has been helpful to you, please consider making a donation to support our efforts.