Before investing in a friend’s or relative’s new business, take steps to cut your losses if the venture goes under. Generally, any loss you incur can only be deducted at $3,000 per year or used to offset capital gains from other sources.
However, section 1244 of the tax code allows you to deduct losses up to $50,000 ($100,000 on joint returns) on “small business stock.” In order to qualify, the company must be a corporation capitalized for $1 million or less.
Thus, it pays to make certain any business you back meets the above criteria, in case things don’t work out. Keep good records to show your loss on this investment. If you have a loss over $50,000 ($100,000 on a joint return), you can deduct it over several years. Suppose, for example, you’re a joint filer who invested $250,000 in Section 1244 stock, which is now worth only $80,000, so you’re $170,000 in the red.
If you sell all your shares in 2001, you can deduct only $100,000 worth of your loss while the other $70,000 is a capital loss deductible at $3,000 per year. Instead, you should sell enough stock to generate a $100,000 loss in 2001 and sell the remaining stock in 2002, when you can deduct the balance of your loss in full.
