Compliance & tax
Section 1244 stock
Tax treatment that converts capital losses on certain small-business stock into ordinary losses, up to $50K single / $100K married filing jointly per year.
Definition
Section 1244 of the Internal Revenue Code provides favorable tax treatment for losses on certain small business stock. When the conditions are met, capital losses on the stock are converted to ordinary losses (up to $50,000 per year for single filers, $100,000 for married filing jointly), allowing the loss to offset ordinary income at higher tax rates. Section 1244 is most valuable for early-stage corporations where founder investments may fail. Once the corporation has received more than $1 million in capital, the § 1244 status doesn't apply to subsequently-issued stock.
Same concept, different references
| US (IRC) | Section 1244 — Losses on small business stock |
|---|---|
| US (IRC) | Section 1244(c)(3) — $1M capital limit |
| Effective | Available on stock issued by qualifying small business corporations |
| Reporting | Form 4797 (Section 1244 loss reported as ordinary income) |
Conditions for § 1244 treatment
For stock to qualify for § 1244 treatment, all conditions must be met:
- Domestic corporation: the issuing corporation must be a domestic corporation
- Original issuance: the stock must have been issued for money or other property (not services). Acquired in secondary purchase doesn't qualify
- $1M capital limit: the corporation must have received less than $1 million in capital contributions in exchange for stock at the time of the loss-stock issuance. Stock issued after the corporation crosses the $1M threshold doesn't qualify
- Active business: the corporation must have derived more than 50% of its gross receipts from active sources (not passive investments) during the 5 years immediately preceding the loss
- Held by original holder: only the original shareholder (or partnership/estate) can claim the loss. Subsequent purchasers cannot
Loss limits and reporting
Section 1244 ordinary loss treatment is capped:
- $50,000 per year for single filers
- $100,000 per year for married filing jointly
- Loss above the cap: treated as capital loss (subject to capital-loss rules — $3,000 ordinary deduction limit, indefinite carryforward)
- Reporting: Form 4797 (Sale of Business Property), Section II
- Documentation: must show stock was issued by qualifying small business corporation when issued — typically with corporate records that prove the $1M threshold wasn't exceeded
Practical importance
Section 1244 is most valuable in scenarios where a closely-held early-stage corporation fails:
- Founder invests $50K in a startup; the startup fails. Without § 1244, the loss is capital — used only against capital gains plus $3K ordinary income per year
- With § 1244, the same $50K loss is ordinary — fully deductible against the founder's other income (consulting, wages, etc.)
- Tax savings can be significant: ordinary income rates (up to 37%) vs capital-loss-against-ordinary-income rate (limited)
- The treatment is automatic when conditions are met; no election filing required
In Octelligence
§ 1244 status preserved in corporate records.
Octelligence tracks the corporation's capital contributions over time, so when a founder needs to demonstrate § 1244 eligibility for a loss claim, the records are ready.
For foundersUS tax structuring
Track every US tax structure at the share level.
Section 351, F reorganization, 338(h)(10), S corp election, AAA, 199A, 1244, BIG tax. Recorded against the corporation, surfaced when relevant.