Sec. 1244 Stock: Turn Small Business Losses into Big Savings

Investing in small businesses can be rewarding, but let's face it, sometimes things don’t go as planned. When faced with potential losses, understanding Sec. 1244 stock can turn a disappointing investment into a strategic tax advantage. We’re here to help you understand the ins and outs of Sec. 1244 stock, and how losses from these investments can be transformed into tax savings.

What we’ll cover:

What is Section 1244 Stock?
What are Section 1244 Stock Losses?
When Can Losses from Small Business Stock Benefit You?

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What is Section 1244 Stock?

Section 1244 stock, known as small business stock, is stock issued after November 6, 1978 that meets the following qualifications:

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The stock is issued directly from the corporation in exchange for money or property
🔑 Stock issued in exchange for services is not Section 1244 stock
The issuing corporation must a 1244 small business corporation: the aggregate amount of money and other property received by the corporation cannot exceed $1M
The corporation’s revenue must come mostly from operations; The corporation cannot derive more than 50% of its gross receipts from passive sources (ex: interest income, dividend income, royalties)

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What are Section 1244 Stock Losses?

When you have a loss from the sale, exchange, or worthlessness of eligible small business stock (1244 stock), you may be able to enjoy preferential tax treatment by characterizing that loss as an ordinary loss instead of a capital loss.

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Ordinary losses from the sale of small business stock are subject to limitations…. → Ordinary loss deductions on 1244 small business stock can reduce taxable income for a maximum of $50,000 ($100,000 for married filing joint returns) in a tax year.

When Can Losses from Small Business Stock Benefit You?

Normally, capital losses from the sale of stock are only allowed to be deducted to the extent of capital gains. In the event that capital losses exceed capital gains, an ordinary loss is available up to $3,000 and any remaining capital losses are carried forward. The benefit of Section 1244 is that losses from the sale of small business stock are treated as ordinary losses and can be taken as a deduction even if no capital gains are recognized.

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Example: You invest $20,000 into a qualified small business corporation after the initial shares of the company are issued. In May, 2022, the value of your investment in the company has gone down to $5,000 and you sell your shares for a $15,000 loss.

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If this stock qualifies as 1244 small business stock:

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This ordinary loss will reduce your taxable income by $15,000.

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If this stock does not qualify as 1244 small business stock:

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Only $3,000 of the $15,000 loss will be deducted against ordinary income and
You will have a $12,000 loss carry-forward.

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This information is for educational purposes only and does not constitute financial advice. Consult a qualified professional before making any investment decisions.

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