Section 1244 Stock

Section 1244 Stock: Definition & Benefits

What is Section 1244 Stock?

Section 1244 of the U.S. tax code allows small business investors to treat losses from qualifying stock as ordinary losses (instead of capital losses) if the stock becomes worthless or is sold at a loss.

Key Benefits of Section 1244 Stock

1. Ordinary Loss Treatment

• Capital Loss vs. Ordinary Loss:

  • Normally, stock losses are capital losses, which can only offset capital gains plus $3,000 of ordinary income per year.

  • Section 1244 allows losses to be treated as ordinary losses, which can offset ordinary income (e.g., wages, business income) dollar-for-dollar.

• Loss Limits:

  • Single filers: Up to $50,000/year ordinary loss.

  • Married filing jointly: Up to $100,000/year ordinary loss.

  • Losses beyond these limits are treated as capital losses.

2. Tax Savings

• Ordinary income is taxed at higher rates (up to 37%) than capital gains (0–20%).

• By deducting losses against ordinary income, investors reduce their taxable income more effectively.

3. Encourages Investment in Small Businesses

• Designed to incentivize investment in startups and small businesses by reducing the risk of total loss.

Qualification Requirements

For stock to qualify under Section 1244:

1. Corporation Requirements

• Must be a domestic (U.S.) corporation.

• Gross receipts: >50% must come from active business operations (not passive income like rents/royalties) for the 5 years before the loss.

• Total capitalization: ≤$1 million at the time the stock is issued.

2. Stock Requirements

• Must be common stock (preferred stock usually doesn’t qualify).

• Issued to the original investor (not purchased on the secondary market).

• Received in exchange for cash or property (not services).

• The corporation must formally designate the stock as Section 1244 stock in its records.

3. Investor Requirements

• Must be an individual or partnership (not a corporation or trust).

• Loss must be realized (stock is sold at a loss or becomes worthless).

Example Scenario

• Situation: You invest $200,000 in a qualifying small business. The company fails, and the stock becomes worthless.

• Without Section 1244:

  • $200,000 capital loss → Only $3,000/year can offset ordinary income (takes 67 years to deduct fully!).

• With Section 1244:

  • $100,000 (joint filers) deducted as ordinary loss in Year 1 → Immediate tax savings.

  • Remaining $100,000 treated as capital loss.

Memory Cheat Sheet

Acronym: "1244 = 1M, 5Y, 50/100"

• $1M: Max corporate capitalization.

• 5Y: 5 years of active business income.

• 50/100: $50k (single) / $100k (joint) ordinary loss limits.

Key Phrase:
"Ordinary loss beats capital loss—save taxes faster!"

When to Use Section 1244

• Investing in small businesses or startups.

• If the business fails, maximize tax deductions by claiming ordinary losses.

• Pair with Section 1202 (QSBS) for gains exclusion (0% tax on gains up to $10M).

Pitfalls to Avoid

❌ Missing documentation: Corp must designate stock as Section 1244 at issuance.
❌ Passive income: >50% of corp revenue must be from active business.
❌ Secondary market purchases: Only original investors qualify.