§1244 Small Business Stock: $100K Ordinary Loss on Failed Startup

$100K Ordinary Loss / Year • vs. $3K Capital Loss Limit • Original Issuance • $1M Cap at Issuance • Both §1202 and §1244
IRC §1244IRC §1244(b)IRC §1244(c)
← Investments & Capital

Section 1244 provides downside protection for small business investors that mirrors the upside protection of §1202 QSBS. If an investor's stock in a qualifying small business becomes worthless or is sold at a loss, up to $100,000 of that loss ($50,000 for single filers) can be deducted as an ordinary loss rather than a capital loss. An ordinary loss offsets any type of income dollar-for-dollar. A capital loss, by contrast, can offset capital gains plus only $3,000 of ordinary income per year - with the rest carried forward indefinitely. For an investor in a failed startup with a $200,000 investment, the difference between §1244 ordinary loss treatment and ordinary capital loss treatment can be significant: $100,000 deducted against wages vs. $3,000 per year for decades.

§1244 Requirements

Qualifying stock: Common or preferred stock of a domestic corporation issued directly to the taxpayer for money or property (not services). Must be original issuance - secondary purchases do not qualify.

$1 million cap: The total amount received by the corporation for §1244 stock (including all prior §1244 stock issuances) must not exceed $1 million at the time of issuance. This means §1244 status is generally available only for early-stage funding rounds before the company has raised more than $1 million in equity.

Active business requirement: For the five most recent tax years before the year of loss (or for the corporation's existence if shorter), more than 50% of gross receipts must have been from sources other than passive income (royalties, rents, dividends, interest, annuities, and stock/security sales). A holding company or investment company does not qualify.

Individual taxpayer: The §1244 ordinary loss is available only to the individual who purchased the stock at original issuance, or to a partnership that purchased the stock. Corporations cannot claim §1244 ordinary loss. A shareholder who acquired the stock by purchase from another shareholder, gift, or inheritance cannot claim §1244 treatment.

The $100,000 Annual Limit

The maximum ordinary loss under §1244 is $100,000 per tax year for married filing jointly, and $50,000 for all other filers. Any loss in excess of these amounts is treated as a capital loss - still valuable, but limited to the $3,000 annual offset against ordinary income plus any capital gain offset. An investor with $300,000 of §1244 stock loss can claim $100,000 as ordinary income (MFJ) and must treat the remaining $200,000 as capital loss in the year of loss.

The same stock can qualify for both §1202 (100% gain exclusion) and §1244 (ordinary loss on failure). This combination represents complete tax symmetry for small business investors: if the company succeeds and stock is sold for a large gain after five years, §1202 can exclude 100% of the gain. If the company fails, §1244 converts the loss to ordinary loss for the first $100,000. The only requirement is that the stock independently meets the requirements of both sections - which it typically does for early-stage C-corporations that meet both the $50M gross asset test (§1202) and the $1M issuance limit (§1244).
Related Tools & Articles
§1202 QSBSSame stock can qualify for §1202 gain exclusion AND §1244 loss Capital Gains CalculatorModel §1244 ordinary loss vs. capital loss limitation Tax Loss Harvesting§1244 stock worthlessness timing - which year to recognize §83(b) Election§1244 and §83(b) planning for founder stock Investments HubAll investment tax topics Business & Entity HubEntity choice - §1244 only available for corporation stock
Authority: IRC §1244(a) (ordinary loss on §1244 stock - loss on sale or exchange or worthlessness of §1244 stock treated as ordinary loss; not capital loss; up to $1 million of losses on qualifying small business stock over taxpayer's lifetime originally; current law per-year limit instead); IRC §1244(b) (annual limitation - $100,000 ordinary loss per year for MFJ; $50,000 for all other taxpayers; excess treated as capital loss; no carryback of ordinary loss portion); IRC §1244(c) (small business stock defined - common or preferred stock; domestic corporation; issued to taxpayer for money or property not services; total amount received for §1244 stock at issuance must not exceed $1 million; active business requirement - more than 50% of gross receipts from non-passive sources for 5 preceding years); IRC §1244(d) (special rules - original issuance required; stock received by gift or inheritance does not qualify; stock received in corporate reorganization may qualify if original stock qualified; partnership holding §1244 stock passes through ordinary loss character to individual partners); Treas. Reg. §1.1244(a)-1 (ordinary loss treatment - applies to individuals and partnerships; not corporations; year of loss is year of sale, exchange, or worthlessness determination); Treas. Reg. §1.1244(c)-2 (small business corporation - $1 million aggregate amount test; includes all equity capital contributions; once exceeded, no new §1244 stock can be issued).