Investors who suffer losses on the sale of stock in small corporations may be enti-tled to special tax treatment if the stock qualifies as “Section 1244” stock. Normally you can deduct only $3,000 of your net capital losses in any one year. But this limitation doesn’t apply to Section 1244 stock. You can deduct up to $50,000 of losses a year ($100,000 on joint returns even if only one spouse owns the stock). Stock can qualify for Section 1244 status if it meets these three tests: 1) The corporation’s total paid-in capital (including the Section 1244 stock) doesn’t exceed $1,000,000. 2) For the five years preceding the loss, the corporation derived most of its income from its business operations. 3) The Section 1244 stock is issued in exchange for cash or property, not stock in another company or securities.
The investor reduced their taxable income by $5,000 by deducting the losses on the sale of their small business stock. Since the investors income was taxed at the 30% tax bracket, the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%).
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by deducting the losses on the sale of small business stock.