Section 1244 Stock: Ordinary Loss on Small Business Shares
How founders and early investors deduct up to $50,000 ($100,000 joint) as an ordinary loss instead of a capital loss — the requirements
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
Section 1244 lets an individual who loses money on stock in a small domestic corporation deduct the loss as an ordinary loss, usable against wages without limit, up to US$50,000 a year (US$100,000 joint) instead of a capital loss limited to US$3,000 a year. The stock must have been issued directly by a corporation with under US$1 million of capital.
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Why does it matter?
A capital loss offsets capital gains and then only US$3,000 of ordinary income a year; a US$50,000 loss on a failed startup's stock could take seventeen years to use. Section 1244 converts the first US$50,000 (or US$100,000 joint) of that loss each year into an ordinary loss deductible immediately against any income. It is one of the few provisions that treats a founder's or angel investor's loss as generously as the income tax treats their gain harshly, and it costs nothing to qualify for — only to fail to.
What are the requirements?
| Requirement | Detail |
|---|---|
| Domestic corporation | A U.S. corporation — C or S corporation both qualify; an LLC taxed as a partnership does not |
| Small business corporation at issuance | The corporation's total money and property received for stock (paid-in capital plus contributions to capital) did not exceed US$1 million at the time the stock was issued — tested when issued, not when sold |
| Stock issued for money or property | Not for services, not for other stock or securities; the original issuance, not a purchase from another shareholder |
| Original holder | Only the person to whom the stock was issued may claim it — stock bought from a shareholder, inherited, or received as a gift does not qualify |
| Individual or partnership | The loss must be sustained by an individual, or by a partnership whose partners were partners when the stock was issued and remained partners until the loss (stock the partnership distributes to a partner loses the treatment); trusts, estates, and corporations do not qualify |
| Active business | For the five years before the loss (or the corporation's life, if shorter), more than 50 percent of gross receipts came from sources other than royalties, rents, dividends, interest, annuities, and gains on securities — an operating business, not a holding company |
| Loss on sale, exchange, or worthlessness | The stock was sold at a loss, exchanged, or became wholly worthless |
No election or filing at issuance is required under current law (an older written-plan requirement was repealed), but the corporation should keep records showing the paid-in capital at each issuance and the gross receipts test — the taxpayer bears the burden of proving qualification when the loss is claimed.
What are the limits?
US$50,000 of ordinary loss per year per taxpayer, US$100,000 on a joint return (even if only one spouse owned the stock). Loss above the limit is a capital loss under the normal rules. The limit is annual, so a US$150,000 section 1244 loss sustained in one year yields US$50,000 ordinary (or US$100,000 joint) and the balance capital — there is no carryforward of the ordinary portion; the excess is simply capital loss. Additional capital contributed after issuance without receiving new stock does not increase the section 1244 basis (the contribution's basis is allocated to the existing shares, but the ordinary-loss treatment applies only to the original basis).
Where are the traps?
Buying stock from a founder rather than from the corporation (not an original issuance); receiving stock for services (founders' "sweat equity" shares don't qualify — the shares issued for cash do); a corporation that crossed US$1 million of paid-in capital before your shares were issued (the shares issued after that date fail, even if the corporation was small when it started); an LLC that never elected corporate status (no stock); and — for S corporations — the loss is claimed only on the stock's disposition or worthlessness, not on the pass-through operating losses the shareholder deducted along the way (which reduced basis and therefore the eventual section 1244 loss).
How does it interact with section 1202?
Section 1202 (qualified small business stock) excludes gain on stock of a qualifying C corporation — after more than five years for stock acquired on or before July 4, 2025, and 50, 75, or 100 percent after three, four, or five years for stock acquired later; section 1244 converts loss on small-corporation stock to ordinary. They cover opposite outcomes of the same investment, and a C corporation startup's founders and angels can be positioned for both: gain excluded if it works, ordinary loss if it doesn't. An S corporation qualifies for section 1244 but not section 1202.
Worked example
Three investors in a failed software startup (a C corporation) whose stock became worthless in 2027. Investor A, married, bought US$140,000 of stock directly from the corporation in its seed round when paid-in capital was US$600,000: section 1244 applies — US$100,000 ordinary loss on the joint return, US$40,000 capital loss. Investor B, single, bought US$60,000 of stock from a departing founder: not an original issuance — a US$60,000 capital loss, US$3,000 a year against ordinary income. Investor C, single, bought US$50,000 of stock directly from the corporation in a later round after paid-in capital had reached US$1.4 million: the corporation exceeded US$1 million at issuance — capital loss only. Same company, three answers, decided by who sold the shares and when.
Frequently asked questions
What is section 1244 stock?
Stock in a domestic small business corporation (no more than US$1 million of paid-in capital when the stock was issued) that was issued directly to an individual for money or property. Loss on it is deductible as an ordinary loss up to the annual limit.
What is the annual ordinary loss limit?
US$50,000 per year, or US$100,000 on a joint return. Loss above the limit is a capital loss; there is no carryforward of the ordinary-loss portion.
Does an LLC qualify?
Not unless it has elected to be taxed as a corporation and has issued stock (membership interests in an LLC taxed as a partnership are not stock). Both C and S corporations qualify.
Does section 1244 apply to S corporation stock?
Yes — the loss is claimed when the stock is sold at a loss or becomes worthless, on the basis remaining after the pass-through losses already deducted.
Official sources
Publication 550 states: “Subject to the limitations discussed under Ordinary loss limit, later, you can deduct as an ordinary loss, rather than as a capital loss, a loss on the sale, trade, or worthlessness of section 1244 stock.” — Internal Revenue Service, Publication 550, Investment Income and Expenses, https://www.irs.gov/publications/p550
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles section 1244 qualification records at issuance, loss characterization on failed investments, and coordination with section 1202 planning for C corporation founders. See pricing or book a call.
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