Section 1244 Stock – Loss of Start-up Investment

The Internal Revenue Code classifies gains and losses as either ordinary or capital gains/losses. The sale or exchange of a capital asset, such as stock held for investment, is usually a capital gain/loss.

General Rule for Capital Losses:

An individual can deduct capital losses up to the capital gains. If capital losses exceed capital gains, the excess is deductible against ordinary income.
Caution: The deduction is limited to $3,000 ($1,500 if you are married filing a separate return).

Section 1244 Stock Special Deduction

An ordinary loss (rather than the less favorable capital loss) can be deducted on the:
! sale
! trade
! or worthlessness (Note the definition of “worthlessness” is an area of factual and legal argument.)

of “Section 1244 stock.” The amount of the deduction treated as an ordinary loss under this special Internal Revenue Code section is limited to $50,000 a year. For tax purposes, IRC classifies the loss as a business loss. On a joint return the limit is $100,000, even if only one spouse incurs this loss. Any gain on Section 1244 stock is a capital gain if the stock is a capital asset.

Requirements for Section 1244 Stock

Section 1244 is stock must be:
! issued for money
! issued for property (other than stock and securities)
! in a domestic small business corporation.

Definition of Domestic Small Business Corporation. During its five most recent tax years before the loss, this corporation must have derived more than 50 percent of its gross receipts from other than:
! royalties,
! rents,
! dividends,
! interest,
! annuities, and
! gains from sales and trades of stocks or securities.

This means most the income must be earned from business operations not mere investments.

Definition: A corporation is a small business corporation if the aggregate amount of money and other property the corporation received for stock, as a contribution to capital, and as paid-in surplus does not exceed $1 million.

Original Ownership Requirement: You must be the original owner of the stock to be allowed ordinary loss treatment. To claim a deductible loss on stock issued to your partnership, you must have been a partner when the stock was issued and have remained so until the time of the loss. There are additional rules for dividends, mergers and reorganizations.