Category: Individuals; Deductions & Credits, Corporations
Subject: Losses
Title: 1244 Stock Loss, Manner of Disposition
IRC Sections: 1244, 302
Filename: 1273.html
Date Produced: 09/95

Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com

Background
TP owns Section 1244 stock in Company X. The Company is about to go into bankruptcy, and the stock is deemed to have no value. TP wishes to disassociate himself with Company X prior to the bankruptcy, and Company X has agreed to redeem TP's stock for $1. In the alternative, other stockholders of Company X may be willing to purchase TP's shares for $1.

Issue
Does TP's loss with respect to his Company X stock qualify for Section 1244 treatment if the stock is redeemed by the Company or purchased by another shareholder?

Answer
Assuming TP shares of Company X qualify in all other respects for Section 1244 treatment, the manner of disposition is irrelevant.

Discussion
Section 1244(a) provides as follows.

In the case of an individual, a loss on section 1244 stock issued to such individual or to a partnership which would (but for this section) be treated as a loss from the sale or exchange of a capital asset shall, to the extent provided in this section, be treated as an ordinary loss.

It seems clear from the plain reading of the statute that the method by which the loss is triggered is not relevant. It is merely sufficient that the stock loss be the result of a sale or exchange of stock which is a capital asset (or even a deemed sale or exchange such as in the case of worthless).

The regulations under Section 1244 do not add anything of value to the concept set forth in the statute. I cannot locate a case or ruling in which the disposition methodology is an issue.

Accordingly, it seems to me that no matter whether TP allows his stock to be redeemed for $1, whether the stock is purchased for $1 by another shareholder, or whether TP holds the stock and takes a worthless stock loss, Section 1244 treatment is preserved.

Of course, some caveats are necessary.

1. Without knowing the details of Corporation X's situation, there could be an issue as to whether the stock is really worthless, and if so when. This issue could come up in either of two totally different contexts. A) Suppose the stock were actually worthless in a tax year prior to the year of disposition by sale or redemption. The Service could potentially take the position that a worthless stock loss should have been claimed in the prior year. Thus, there would be no loss on sale or redemption. B) Going the other way, suppose the stock is really not worthless at the time of sale or redemption. The Service could claim the sale or redemption is a sham. Note that a mere bankruptcy filing does not in and of itself establish worthlessness. Many companies ultimately emerge from the bankruptcy process with some value intact.

2. If the redemption route is chosen, make sure the transaction qualifies as a redemption under Section 302. This must be investigated thoroughly. Otherwise, there is no sale or exchange treatment which is a requirement for Section 1244. Make absolutely sure that all of TP's shares are redeemed. If TP is related by blood or marriage or has any business relationships with any of the other shareholders of Corporation X, the redemption option may not work.

3. Any tax provision that would otherwise serve to disallow or defer a loss is equally applicable in this context as well, e.g., Section 267.

4. Anything that would cause TP's stock in Corporation X to be something other than a capital asset would be fatal to Section 1244 treatment. The only circumstance that readily comes to mind is that of a securities dealer; however, there may be others.