Section 1244 Stock: Converting Capital Losses to Ordinary Losses on Small Business Stock
When a business investment fails, the tax treatment of the loss determines how quickly the investor can recover some of the economic damage through tax savings. Under the default rules, a loss on stock is a capital loss, deductible only against capital gains plus $3,000 of ordinary income per year (with the excess carried forward indefinitely). For an investor who put $200,000 into a startup that went to zero, it would take over 66 years to fully deduct the loss at $3,000 per year (assuming no offsetting capital gains). IRC 1244 changes this outcome dramatically by allowing qualifying small business stock losses to be treated as ordinary losses up to $50,000 per year ($100,000 MFJ). An ordinary loss is fully deductible against wages, business income, interest, and any other type of income, with no annual dollar limitation beyond the Section 1244 cap. For the investor with the $200,000 loss, Section 1244 treatment means deducting $100,000 per year for 2 years (MFJ), generating tax savings of approximately $74,000 at the 37% rate, compared to waiting decades under the capital loss rules.
Section 1244 requirements:
| Requirement | Details |
|---|---|
| Domestic corporation | Must be a U.S. corporation (C-Corp or S-Corp) |
| Small business corporation | Aggregate money and property received by the corporation for stock, contributions to capital, and paid-in surplus can’t exceed $1 million at the time the stock is issued |
| Issued for money or property | Stock must be issued in exchange for money or property (NOT for services, stock of another corporation, or securities) |
| Active business test | More than 50% of the corporation’s gross receipts for the 5 most recent tax years must be from sources other than royalties, rents, dividends, interest, annuities, and sales of securities |
| Individual shareholders only | Only individuals (not trusts, estates, or entities) can claim the ordinary loss |
| Original issuance | Must be acquired directly from the corporation (not purchased on the secondary market) |
Annual loss limits:
| Filing Status | Maximum Ordinary Loss Per Year |
|---|---|
| Single | $50,000 |
| Married Filing Jointly | $100,000 |
| Married Filing Separately | $50,000 |
Losses exceeding these limits are treated as capital losses (subject to the $3,000 annual deduction limit).
How does Section 1244 protect your investment in a startup?
How is the self-employment tax calculated?
Self-employment tax is 15.3% on net self-employment income up to the Social Security wage base ($168,600 in 2024), then 2.9% on income above that threshold. Net self-employment income is calculated as 92.35% of your Schedule C net profit (the 7.65% reduction approximates the employer-half FICA deduction that W-2 workers receive). You deduct half of the self-employment tax on Schedule 1 of Form 1040, which reduces your AGI and income tax but does not reduce the SE tax itself. The additional Medicare tax of 0.9% applies to combined wages and self-employment income exceeding $200,000 ($250,000 married filing jointly). This makes the effective rate on high-income self-employment earnings 16.2%.
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Yarik Yarosh, CPA. "Section 1244 Stock: Converting Capital Losses to Ordinary Losses on Small Business Stock." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-section-1244-stock-ordinary-loss-qualification
This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.