There are two ways, and they’re different kinds of thing. You can claim the position became worthless, which is an assertion about value and timing that you have to be able to support. Or you can sell it, which is a dated event with a buyer, a price, and an agreement. Most people who ask this question are holding a position that fits neither cleanly yet — the company didn’t announce anything; it just stopped. This page lays out both paths so you can figure out which case you’re actually in before you talk to your advisor.
First, which case are you in?
Private investments end in one of three ways, and the paperwork you hold tells you which:
It ended with a document. A dissolution notice, a bankruptcy filing, a final K-1 marked “final,” or a letter saying shareholders will receive nothing. You have an identifiable event and a year. This is the clean case.
It ended in silence. The updates stopped, the founders stopped answering, and nothing ever arrived saying it was over. You can’t tell whether it wound up or is still sitting on a small balance. This is the common case, and it’s covered in detail in The startup I invested in went silent.
It hasn’t ended. The company is small and quiet but alive, or you believe a recovery is plausible. Then there’s nothing to write off yet, and no one should talk you into thinking otherwise.
If you’re in the third case, stop here. The rest of this page is for the first two.
Path one: claim it as worthless
Under §165, a security that becomes wholly worthless during a tax year is treated as if sold on the last day of that year. To claim it you have to be able to show two things: that the position has no value at all — not “probably dead,” but nothing, including no liquidation value — and that it became worthless in the specific year you’re claiming, tied to an identifiable event. If it actually went worthless earlier, the loss belongs to that earlier year.
With a document in hand, this can be straightforward. Without one, it’s an argument you and your advisor have to build and be prepared to defend.
For an unconverted SAFE or an uncollectible convertible note, there’s an added question of what kind of loss it is — capital loss, nonbusiness bad debt, or something else — depending on how the instrument is characterized. Your advisor decides that.
Path two: sell it
Under §1001, selling a position to a buyer for consideration produces a realized gain or loss on the date of the sale. It’s reported on Form 8949 and Schedule D like any other sale. You aren’t asserting that the position is worth nothing; you’re reporting what you sold it for and when. That sidesteps the two questions that make the worthlessness path hard.
What it requires instead is a real sale: an unrelated buyer, actual consideration, an executed agreement, and a transfer you can document. A sale to a relative, to an entity you control, or to a friend who hands the shares back later doesn’t qualify — losses on related-party sales are disallowed under §267.
The practical obstacle has always been the buyer. There’s no market for a defunct startup’s stock. A documented sale through DivestMe costs a flat $150 per position. DivestMe LLC exists to be the buyer: it counter-signs the Asset Sale Agreement, takes the position outright, and delivers the executed agreement and a Certificate of Completion, creating a dated disposition. The purchase price is nominal, $1.00, because a position with no market has no price to discover; the dollar is consideration, not a valuation, and it is what makes the transaction a sale rather than an abandonment. What that sale means on your return — whether a loss is allowed, in what year, in what character — is still your advisor’s determination; DivestMe documents the sale and does not decide eligibility.
If you hold a convertible note
A convertible note that will never be repaid raises a question stock doesn’t: whether the loss is a worthless-security loss under §165(g) or a bad-debt loss under §166. The answer depends on whether the note is a ‘security’ as §165(g)(2) defines it (generally, a note in registered form or with interest coupons) and, if not, whether the debt was business or nonbusiness. A nonbusiness bad debt is treated as a short-term capital loss and must be wholly worthless to be deducted. A sale of the note is a disposition of the note as property, whatever its characterization. Which rule applies to your note is for your advisor. (See IRS Publication 550.)
Why it matters
If you’re not sure why anyone bothers, here is the general shape of it, as the rules treat capital losses — not as a prediction about yours.
When an investment is sold for less than it cost, the difference is a capital loss. The tax code lets capital losses offset capital gains — a loss on one investment can reduce the tax owed on a gain from another. When losses exceed gains in a year, a limited amount can be applied against ordinary income, and whatever remains carries forward to future years rather than disappearing. Some small-company stock may qualify for different, ordinary-loss treatment under §1244, within limits. See IRS Publication 550.
None of that is automatic, and none of it is a statement about your position. Whether a loss is allowed at all, in which year, in what character, and against what — those are determinations your advisor makes from the facts you bring.
Which path?
The honest answer is that it depends on your facts and your advisor’s judgment, and the two paths are compared directly in Worthless-security deduction or sell it: which is better?. The short version: a document-backed worthlessness claim needs no buyer; a sale needs no argument about value or timing. Silence tends to push toward the second, but that’s an observation, not advice.
What your advisor will need either way
Gather these before the conversation; they’re the same for both paths:
- What you bought, and from whom: stock, preferred, SAFE, note, LLC or LP interest.
- Cost basis — what you actually paid, plus any later contributions.
- Acquisition date, and the subscription or SAFE document itself.
- Every communication from the company since, including the last one.
- Any K-1 or 1099 ever received, and the last year one arrived.
- Whether the stock might be §1244 small-business stock (possible ordinary-loss treatment, subject to limits your advisor will check).
How a capital loss is reported
A loss on a capital asset is reported on Form 8949, with totals flowing to Schedule D. Capital losses offset capital gains; up to $3,000 of any remaining loss ($1,500 if married filing separately) can offset ordinary income in a year, and the rest carries forward to later years. An ordinary loss under §1244, where it applies, is reported on Form 4797. These are the reporting rules in IRS Publication 550; whether a loss is allowable, in what year, and in what character is determined by the taxpayer and their advisor.
Timing
A sale counts for the year it closes. A disposition executed on December 31 belongs to that year; one executed on January 1 belongs to the next. If you and your advisor decide a sale is the right path and you want the loss in the current year, the paperwork has to be complete before year-end — not started.
If you think the position may have gone worthless in a prior year, raise that with your advisor before doing anything else. That’s a separate question with its own answer.