Protecting Your Section 1244 Deduction

If you own stock in a small corporation and the corporation suffers a business failure, its stock can become worthless. Being able to deduct a loss on the stock as an ordinary loss as opposed to a capital loss can save you a bundle in taxes.

An ordinary loss is fully deductible in the year of the loss, while a capital loss incurred by an individual has an annual deduction limit of $3,000 and any excess over $3,000 must be carried forward to the following tax year.

Keeping the appropriate records is critical to protection your deduction. The IRS can disallow ordinary loss tax treatment permitted under IRC Section 1244 if you do not have the appropriate supporting documentaton.

What You Should Do

Make a Reference in Your Corporate Records:

If you set up a corporation, your corporate records must document the fact that the stock issued qualified as Section 1244 stock because, if audited, the IRS may inspect your corporate records to determine if there is a reference to that fact.

Check the requirements for qualifying for Section 1244 stock.

Gross Receipts

Provide a record of the corporation's gross receipts data for five years or whatever number of years the corporation has been in existence.

Retain Information About Shares Purchased:

If you are the purchaser of stock of a small business corporation, you need to retain information about the shares you purchased.

Keep a record of:

  • the number of shares received
  • the date the stock was issued to you, and
  • the price paid for the stock.

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  • See the Tax Basics for Startups table of contents and scroll down to the Section 1244 Stock link for more information.