Q Dear Rick:
I have a couple of tax questions I hope you can help me with. Earlier this year I was notified that a company I had purchased stock in about three or four years ago, went out of business and their stock is totally worthless. My cost basis in that stock was $75,000. I am obviously not happy about this but at least I get the tax write-off. What I was thinking of doing is selling some other stocks that I have with gains that would virtually offset the $75,000 loss. What I plan to do is to sell the stock and then immediately buy it back. My first question is do I violate any tax law by rebuying the stock? I recently read one of your columns where you talked about selling stock and rebuying that there could be problems for tax purposes. My second question is that I plan to sue my accountant who recommended that I purchase the stock of the company that went belly up. I am curious; if I win do I have to pay tax on the money?
A Dear Brad:
The transaction you want to do, selling the stock with a gain, recognizing that gain for tax purposes and then turning around and rebuying the stock, does not violate any tax laws. If the stock you were selling had a loss, then there is what is known as the wash-sale rule that prevents you from rebuying that stock 30 days before and 30 days after you sold the stock. In the situation at hand, since the stock you’re selling has a gain, then there is no problem rebuying the stock back.
Performing the transaction that allows you to use the entire loss generated by the company that went belly up, is also allowed. Unfortunately, the way our tax laws work is when you have gains, you have to recognize those in the year of sale. With losses it doesn’t always work that way. When it comes to losses, the first thing to do is offset any similar gains. If there are no gains, then your losses are limited to $3,000 a year. The remaining losses can be carried forward into future tax years. However, in your situation, by selling a stock that has a gain, you are actually able to use the entire loss in this tax year.
With regard to the lawsuit, more likely than not, if you are successful, the amount of money you receive is going to be subject to income tax. Many people are under the mistaken belief that proceeds from a lawsuit are not taxable; that is not the case. Most of the time when someone does receive money pursuant to a lawsuit, there are tax consequences. The exceptions are for things like personal injury lawsuits. Typically, in those types of lawsuits, that income is not considered taxable income.
Good luck on your lawsuit and my advice is to make sure you retain the services of an experienced attorney who has handled these types of cases before. In addition it is important to discuss fees and costs upfront. Many Attorneys will take this type of case on a contingency basis which means they will take a percent of your winnings, while other Attorneys will work on an hourly basis. The key is to make sure you understand all costs and fees before you retain the Attorney. Lastly remember there is nothing wrong with trying to negotiate the fees.