Ask SmartMoney: Handling Worthless Stock

ANSWER: Sorry to break bad news but...yep, you lost all your money. When Dana entered Chapter 11 in March 2006, the stock was booted from the New York Stock Exchange and moved to the over-the-counter market, trading on what's known as the Pink Sheets, at $0.80 per share. As of Jan. 31, 2008 — the last day it traded — a share was worth significantly less than a penny. Dana has since emerged from the restructuring with a new share class trading on the NYSE. But those old shares? Still worth nada.

In these situations the IRS treats the "sale" as if it were made on Dec. 31 of the year the shares became worthless. Keep in mind the shares must be truly worthless (yours are) — meaning they're no longer tradable and you're not entitled to any sort of payment from the company. In other words the stock isn't worth a penny. But hey, the tax break is worth at least something.

QUESTION: If I inherit an IRA, can I transfer it immediately into a Roth without having to pay taxes?
— Sami Gallian, New York City

ANSWER: Nope. That money went into the account tax-free, and whether you convert it to a Roth or liquidate it entirely, you're going to owe income tax on the full amount (except in the rare case of any after-tax contributions). In fact even if you are willing to pay the tax, you still might not be able to convert. Inheriting an IRA is tricky business — the rules vary based on whom you inherit the IRA from. If it's a spouse, you can opt to take over the account and then convert it to a Roth — but only if your annual income is below $100,000. If you inherit it from someone other than your spouse, you're flat out of luck; your only options involve how quickly you liquidate the account — which can range from days to decades. If you're feeling particularly cheeky, ask your benefactor to convert to a Roth, assuming he or she qualifies, says IRA expert Ed Slott of Rockville Centre, N.Y.

QUESTION: I've lost money on Vanguard's High Yield fund (VWEHX). Should I sell it, take a tax loss and then buy T. Rowe Price's High Yield fund (PRHYX) so I can keep my income steady? The yields on both funds are about the same.
— E. Lucas, Harahan, La.

ANSWER: That's a smart move. Selling one fund at a loss and immediately buying a similar fund allows you to capture a sweet tax break, while keeping exposure to the same corner of the market. Like the worthless stock mentioned in the first question, these so-called "realized losses" can be used to offset capital gains, plus up to $3,000 in ordinary income.

ANSWER: If you go down this road, however, make sure you steer clear of a few potholes. First know that you can't repurchase the Vanguard fund right away. If you do, you'll run afoul of the wash-sale rule, which disallows the tax loss if you reinvest in a "substantially identical" security within 31 days. Another fund with a similar strategy is okay, but remember that no two funds are exactly alike, no matter what their names say, warns financial planner Harold Evensky of Coral Gables, Fla. T. Rowe Price's High Yield fund, for example, carries an average credit quality of B, while Vanguard's is a slightly higher BB, according to Morningstar. Also beware of redemption fees; the T. Rowe Price fund has a 1 percent redemption fee on withdrawals taken within 90 days.

Also See:

Ask SmartMoney: The Best Way to Pay for Home Remodeling?

Ask SmartMoney: Home Short Sales

Ask SmartMoney: Your Tax Questions Answered