Section 1244 Stock: Definition, Treatment, and Practical Applications

Section 1244 stock, embedded in the IRS tax code, specifically addresses the tax treatment of restricted stock. Its primary function is to allow losses incurred from the sale of shares in small domestic corporations to be deducted as ordinary losses, deviating from the typical categorization as capital losses. Notably, individual tax returns can claim up to $50,000, while joint returns have a cap of $100,000 for such deductions.

In the realm of startups and small businesses, where risk is inherent, Section 1244 emerges as a critical provision. Its significance lies in the permission it grants for specific capital losses to be treated as ordinary losses. Unlike capital losses, ordinary losses are fully deductible in the year they occur, providing a substantial tax advantage to companies navigating uncertainties.

Importantly, these ordinary losses are not offset by capital gains, allowing companies to leverage the lower tax rates associated with capital gains. This unique treatment enhances financial flexibility by reducing taxable income through ordinary losses while still enjoying the benefits of lower tax rates.

Section 1244 losses hold a dual identity; they are not only ordinary losses but are also considered trade or business losses when calculating an individual’s net operating loss (NOL). This distinction is crucial as Section 1244 losses aren’t subject to limitations imposed by non-business income, offering additional relief.

An exclusion to note is that Section 1244 does not apply to contributions made after the initial issuance of shares. However, later contributions can qualify if the investor receives authorized but not issued shares. Issuance of Section 1244 stock should align with a written corporate resolution. Individual shareholders can claim losses using Form 4797, Sales of Business Property, and must file it with their individual income tax return.

Section 1244 treatment can be applied to both common and preferred stocks, but with a crucial distinction. If the shares were issued before July 19, 1984, only common stock qualifies for this tax treatment.

To qualify, a corporation’s aggregate capital must not have exceeded $1 million when the stock was issued, and the corporation cannot derive more than 50% of its income from passive investments. Additionally, a majority of the corporation’s revenues must come directly from operations, not from interest, dividends, and royalties.

Section 1244 losses can be claimed by individual shareholders, but a key condition is that the shares must be purchased directly from the company, not received as compensation. Continuous ownership of the shares since the date of issuance is also required, without any exchange in the market or through private transactions.

Section 1244 stock loss can be claimed on Form 4797, Sales of Business Property, and must be filed with the shareholder’s individual income tax return.

There is no specific time limit mentioned for claiming Section 1244 stock losses, but adherence to tax filing deadlines is crucial for the accurate processing of such claims.