Sitting down with your tax return can be a painful reminder of investments gone bad. But remember, in most cases you can't deduct a loss on a stock unless you "realized" it by selling the misbehaving shares before the end of the year. The IRS just doesn't want to hear about your "paper" losses.

But there is an exception to that rule. You can deduct a loss on a worthless security without selling it. But, what constitutes worthlessness in the eyes of the IRS? Well, a company going bankrupt isn't necessary enough. The IRS says that if there's any chance a stock can recover, it's not wholly worthless.

What if you're convinced a stock isn't coming back? It would be nice if you had a note from your broker saying the stock ceased trading in 2007, or a news article about the firm liquidating and evidence that it owes more to creditors and bondholders than the total of its assets. In other words, there won't be anything left for shareholders.

But what if the stock still shows up trading on the pink sheets with an asking price of a fraction of a penny per share? Some advisers say that miniscule value means the stock is not worthless. But an experienced CPA and a long-time IRS employee both told me that if your block of stock would bring less than the broker's commission for selling it, they'd claim a worthless stock deduction -- assuming they had evidence that the company met its demise in 2007.

To write off a worthless stock, you report it on Schedule D as though you sold it for $0 on December 31. That date also determines whether you have a short- or a long-term loss. In the section where you're asked for the sale date and selling price, just write "worthless." Your loss is the full cost of the stock.

MORE: Kiplinger.com | Your Money | Taxes | Column

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