Section 1244 Stock: Everything You Need to KnowStartup Law ResourcesBusiness Operations
A section 1244 stock is a stock market loss allowing you to claim losses from the sale of shares in small companies as regular losses instead of capital losses.3 min read
What Is Section 1244 Stock?
A section 1244 stock is a stock market loss that allows you to claim losses from the sales of shares in small companies as regular losses rather than capital losses. Individuals can claim losses of up to $50,000, and couples may claim up to $100,000. (In contrast, capital losses are subject to an annual deduction limit of only $3,000).
Some advantages of claiming 1244 losses are that claiming ordinary losses does not prohibit you from enjoying capital gain rates (if you have capital gains in the same year), and they offset other income taxed at ordinary rates.
You claim a section 1244 stock loss on line 10 of Form 4797. Any loss in excess of the limit should be reported on Schedule D, Form 1040.
To qualify for a section 1244, a company must meet certain requirements:
The corporation must be a domestic small business corporation at the time the stock is issued. Aggregate capital cannot be over $1 million at the time of issue. In its transitional year (the first taxable year in which the $1 million mark is exceeded, the corporation must designate which shares are 1244 for that year.
In the five tax years preceding the loss, the corporation cannot have received than 50 percent of its income from passive investments such as royalties, rents, dividends, interests, annuities and sales or exchanges of stocks or securities. This is the “gross receipts test”. This does not apply if cumulative deductions exceed cumulative gross income during the 5 year period. Corporation must also be an operating company (not just a holding or investment company) for the 5 year testing period.
Shareholders must have bought and paid for the stocks themselves and not received them as bonuses or incentives from the company, and must be an individual or partnership. Taxpayers who purchase existing corporation’s stock do not get section 1244 treatment as they are not the original owners. To have section 1244 apply, they can purchase the corporation’s assets and transfer them to a new corporation.
The stock must have been acquired after June 30, 1958, and only common stock may qualify as section 1244 stock if issued before July 18, 1984. Securities of the corporation convertible into common stock, nor common stock convertible into other securities are not treated as common stock for these purposes. Cancellation of a debt in exchange for stock does qualify for section 1244 treatment unless the debt is evidenced by a security or arises out of performance of personal services. If, however, debt is worthless at the time the stock is exchanged, a section 1244 loss will not be generated. If the stock was issued prior to November 1978, special considerations apply, and it must have been issued under a written plan which meets the requirements of section 1244.
You must have held the stock continually as an individual, or partnership since the date the stock was issued. Generally, transfers of 1244 stock by the shareholder (death, gift, sale or exchange) end the eligibility for 1244 status. Losses on section 1244 stock cannot be claimed as ordinary losses by shareholders in S corporations which sell that type of stock.
How Does Section 1244 Stock Affect You?
You may think there is never an upside to investing in a start-up that suddenly falls apart, but there is. The U.S. government provides a loophole that benefits angel investors brave enough to take these risky investments. You just need to know how to recover some of your losses and cut down your tax bill.
Tax strategies also exist to help angel investors keep more money in their pockets when their investments pay off. This information is important because it helps keep angel investors in the game. Otherwise, they would not be able to fund new start-ups to keep the economy going.
It is essential that you understand federal income tax laws; however, you can put these laws aside for a while when you have a savvy angel investment strategy. To start, you must carefully evaluate the potential of a business. You must analyze its sustainability and evaluate the current team. Then, you can take into account the tax considerations.
If you need help negotiating contracts with Angel Investors, post your legal need on UpCounsel's marketplace. UpCounsel screens out 95 percent of lawyers to provide only the best ones from top schools such as Harvard Law School and Yale Law School. UpCounsel lawyers have an average of 14 years’ experience and have provided legal services to prominent companies, including Menlo Ventures, Airbnb and Google.