Section 1244 stock encourages new investment in small business by permitting investors to claim ordinary losses on risky investments.
What is Section 1244 Stock?
Stock is considered a capital asset and subject to capital gain tax rates. Losses that exceed gains are limited to a $3,000 annual deduction and excess must be carried over to next year.
Section 1244 of the Internal Revenue Code allows eligible shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than a capital loss. Eligible investors include individuals, partnerships and LLCs taxed as partnerships.
Another benefit is that the ordinary loss can be deducted up to $50,000 ($100,000 on a joint return). Any loss in excess of the limit is capital loss. Any loss that qualifies as an ordinary loss under Section 1244 is also classified as a trade or business loss when computing an individual’s net operating loss.
The requirements are as follows:
- The stock must be issued by a U.S. corporation, including S corporation.
- The corporation’s equity may not exceed $1,000,000 at the time the stock is issued.
- The stock must be issued for money or property (other than stock or services).
- For the five years preceding the loss, the corporation must generally have derived more than half of its gross receipts from business operations, not passive income.
- Only individuals who purchase the stock directly from the company qualify.
Losses are claimed by individual shareholders on Form 4797 and must be filed with the shareholder’s individual income tax return.
You may have thought there was no upside to investing in a start-up that suddenly falls apart. If you believe that you own stock in a corporation that is eligible for Section 1244 treatment, contact a Windes tax advisor before year-end to discuss the tax benefits.
For more information about this article, please contact Rob Henderson at rhenderson@windes.com or toll free at 844.4WINDES (844.494.6337).