Corporate Bankruptcy and Your Investments
Bankruptcy creates tax challenges for investors, both shareholders and bondholders. Though the ideal situation is to sell a security before a company files for bankruptcy, once the bankruptcy process starts, investors need to make decisions about what to do with their securities. These decisions are often tied to assumptions based on incomplete information.
In the advent of bankruptcy, the interests of bondholders are favored over those of shareholders. Owners of common stock also see their interests take a back seat to those of preferred stock owners. However, holding bonds does not guarantee priority, as some bonds are “senior,” while others are “subordinate.”
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A bankruptcy can result in a reorganization or a sale of the company’s assets. Under a reorganization, bondholders may receive stock in the new company. Shareholders may see their ownership interests completely eliminated. Each bankruptcy is different. Investors need to read the provided documentation to determine what the company’s intentions are and how their stocks or bonds may be affected.
Once the bankruptcy is announced, investors have the opportunity to either sell their holdings or wait for the bankruptcy proceedings to be completed. Selling the security creates a formal capital loss (assuming the security was purchased above its post–bankruptcy announcement price). Waiting for the bankruptcy proceedings to be completed creates the potential to record the holding as “worthless” and claim an even larger capital loss.
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