Tax Tips: How to Make the Most of a Bad Investment

Bad investment
Bad investment

It happens to even the best investors: Sometimes, what seems like a smart investment turns out to be a big loser. But even if you suffer a complete loss, you can still salvage something from your experience when you file your tax return.

Whenever you sell an investment that you own, you generate what's called a capital gain or loss. If your investments have done well, then the resulting gain boosts your taxable income, and therefore your tax bill goes up.

But if the investment you sell has lost value, then the resulting capital loss can bring you some tax savings.

Sometimes, though, you'll lose everything on an investment you still own. For instance, when companies declare bankruptcy, their stock often becomes worthless. But if that stock stops trading on the public markets, you may lose the chance to sell your shares to claim your loss.

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Fortunately, the IRS in some circumstances lets you claim a complete loss without actually selling your investment. Known as the worthless stock provisions, the tax law basically allows you to act as though you had sold the shares -- as long as they truly have no value.

To claim losses on worthless stock, you complete your tax forms in much the same way you would a regular capital loss on a stock sale. The sale date is treated as if the loss happened on the last day of the year, and you can put the word "worthless" in the spots for the sale date and sales price columns. But you'll get the same write-off you would from actually selling the shares for nothing -- and you won't have to pay a brokerage commission or other fee to do so.

Obviously, no one wants to suffer a total loss. But if it does happen, you might as well get as much of a tax benefit from it as you can.

For more on smart tax moves:

Motley Fool contributor Dan Caplinger has done fairly well avoiding total losses so far, but he doesn't want to tempt fate. You can follow him on Twitter here.