Question

When an investor holds a stock that has lost nearly all of its value, the investor will often times sell the stock to her stock broker for the total sum of $1. Why do they do that? Legally, what happens if the company recovers and the stock becomes worth $1 million?

Answer 1

Answer: - An investor purchases a stock for the purpose of capital appreciation in the stock. He keep the stock for the long term with and when the stock makes a good wealth he sells the stock in the capital market for good profit by way of the capital appreciation that is more profit in terms of increase in its marlet value. When an investor earns a good capital appreciation he sells the stock and is liable to pay the tax as per the regulation in which he is a resident of that nation.

However there are chances of the opposite side of the case that is an investor has purchased the stock and the stock has lost nearly all of its value. Hence there can be 2 scenarios for the investor that is he can either hold the stock and wait till the time the stock can give good capital appreciation or in the other case he can either sell the stock in the market and can have a capital loss that is the loss from sale of securities which have been sold at a loss as the market value of such stock have lost there whole capital value. Hence the investor has who has incurred the capital loss can use that capital loss and get the same setoff against any capital gain. Hence his net tax liability will reduce due to the capital loss that the invesor has incurred due to the sale of securities at reduced prices in the capital market.

However from the company point of view whose stock was earlier trading at $1 and now the stock price of the same has recovered and has become $1 million hence the market capitalisation of the company will increase. Earlier the stock price has fallen because of its poor performace and has become $1 the company might not being paying the taxes on its losses and now the company has started earning he will be liable to pay tax on the same as the company has earned and the stock prices have increased.