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Situation:

  • I held N shares of a company "JUNK", average cost basis $C/share.

  • Cost basis for the shares was $C * N.

  • Some time later, company "JUNK" filed for Chapter 11 bankruptcy.

  • At this point, the stock was listed at price of zero.

  • A Chapter 11 plan was approved by the judge, in light of the fact that the company had recoverable assets (mostly via litigation against senior management).

  • The Plan, as approved by court, included distribution to pre-Chapter-11 equity holders of any assets from Recovery Trust, left after higher-priority payouts (administrative expenses, secured and unsecured creditors etc...)

  • At the end of the execution of the plan, the Recovery Trust held some money, which amounted to $C2 per share on average, distributed to equity holders.

  • As such, i'm entitled to distribution of $C2 * N.

Question: What would be the tax calculations?

  1. Would the Plan distribution of $C2 * N be considered capital gains on that stock, same as if I simply sold the original stock for $C2/share?

    In other words, if $C2 is more than $C (original cost basis), I would pay long-term investment taxes on ($C2-$C) * N; and if $C2 is less than $C, I would be able to write off ($C-$C2)*N from my capital gains otherwise?

  2. Or, would the distribution be separate investment income?

    If so, would I be able to write off the loss of original $C*N investment and how? Does the fact that it has been several years since bankruptcy matter? (not sure if this should be a separate question).

    Would the distribution be taxed as long or short term capital gains?

  3. Or, would the distribution be separate non-capital-gains, and taxed like regular income?

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  • Tax questions require a country tag.
    – Chris W. Rea
    May 16, 2019 at 3:26
  • @ChrisW.Rea - based on the expression "Chapter 11 bankruptcy", USA seems like a pretty likely case.
    – user2932
    May 16, 2019 at 20:45
  • @user2932 Perhaps. However, people from around the world do invest in U.S. stocks, and it is primarily the investor's own country's tax rules that matter w.r.t. taxation of any gains or income etc.
    – Chris W. Rea
    May 16, 2019 at 23:11
  • @user2932 For instance, as a Canadian investing in U.S. stocks [and this is not just a hypothetical], the short- vs. long-term capital gains rules that Americans are concerned with do not apply to me, as Canada has no such distinction. That may be the stronger clue here.
    – Chris W. Rea
    May 16, 2019 at 23:14
  • @ChrisW.Rea - would anyone by an American on StackExchange not bother adding a country? :-P
    – user2932
    May 16, 2019 at 23:26

1 Answer 1

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(For US, as tagged.)

  1. Would the Plan distribution of $C2 * N be considered capital gains on that stock, same as if I simply sold the original stock for $C2/share?

Exactly. For tax purposes this is a forced sale; they cancelled the stock and gave you cash. The same is true when a (public) corporation is acquired for cash, or is 'taken private'. Compare If I get cash compensation for my stocks (following a merger for example) does that qualify for capital gains tax? (although that's not purely US).

In other words, if $C2 is more than $C (original cost basis), I would pay long-term investment taxes on ($C2-$C) * N; and if $C2 is less than $C, I would be able to write off ($C-$C2)*N from my capital gains otherwise?

Yes and yes, plus if you have a net capital loss, you deduct up to $3,000 per year from 'ordinary' income ($1,500 if married filing separately), with anything over that limit carried forward to the next year(s). See Schedule D line 21, and Schedule 1 of the newly reorganized 1040.

(Other parts of Q omitted as irrelevant.)

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