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Section 1244 - Losses on Small Business Stock

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Who Can Claim an Ordinary Loss on Section 1244 Stock?

Only individuals who originally purchased the stock may claim an ordinary loss on Section 1244 stock.

If you received the stock by gift, inheritance, or purchased it from an original purchaser, you cannot claim an ordinary loss deduction on the stock (which is fully deductible up to certain limits), you may only claim a capital loss (which is deductible only up to $3,000 per year).

Partnerships:

If a partnership purchases Section 1244 stock of another company, and later disposes of it at a loss, it may pass the loss through to the partners.

To be allowed to claim the loss as an ordinary loss instead of a capital loss, you must have been a partner when the stock was issued and have remained so until the time of the loss.

Caution! If the partnership entity owns Section 1244 stock and distributes the stock to its partners, they may not claim an ordinary loss on their disposition of the stock, instead, capital loss treatment applies

S-corporations:

Although and S-corporation and partnership are both pass-through entities, they are treated differently for a loss on Section 1244 stock passed through the entity to the owners.

As mentioned earlier, a partnership passes a loss on Section 1244 stock to its owners who deduct the loss as an ordinary loss on their own tax returns.

However, this is not the case for S-corporations.

If an S-corporation owns Section 1244 stock and incurs a loss on the stock, S-corporation shareholders cannot deduct the loss as an ordinary.

S-corporation shareholders must deduct the loss on Section 1244 stock, which is owned by the S-corporation, as a capital loss.

Capital losses are limited to $3,000 a year.

This difference in tax treatment of a loss by owners of a partnership or S-corporation, where the entity itself owns Section 1244 stock and passes a loss on such stock through the entity to its owners is an important distinction between both types of entities.

Partners get to deduct the loss as an ordinary loss while S-corporation shareholders must deduct the loss as a capital loss.

Where to Claim a Section 1244 Loss

Form 4797, Sales of Business Property, is used to report an ordinary loss on the sale of Section 1244 stock or a loss resulting from the stock becoming worthless.

Attach Form 4797 to Form 1040.

A gain on Section 1244 stock is reported on Schedule D as a capital gain.

Section 1244 - Losses on Small Business Stock: Section 1244 Deduction Limits

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