Invested in equity in a Startup C Corp. Lost all and sued with no success.Can I offset loss against my stock portfolio capital gains? Would section 1244 apply?

[Critter-3]

You can take a deduction for a nonbusiness debt only if the entire debt is uncollectable. You do not have to wait until the entire debt is overdue to determine whether it is worthless. Nor do you have to file a lawsuit to collect the debt, obtain a judgment against the debtor, and then try, unsuccessfully, to collect on it — a process that can take years.

All that is required is for you to show that there is no longer any chance that the loan will be repaid. Obviously, you must show that you took reasonable steps to collect the debt. But even such collection efforts would not be required if the debtor files for bankruptcy, since such a filing stops all debt collection efforts by the debtor’s creditors.

Nonbusiness bad debts are treated as short-term capital losses. Such losses are first deducted from your short-term capital gains, if any. If your net short-term loss exceed your short-term gains, your net short-term capital losses are then deducted from your total long-term capital gains for the year. If your net short-term loss exceeds the long-term gain, the excess short-term loss is deductible against up to $3,000 of your other income. Any amount remaining can be carried forward and deducted in future years. 

• Report this in TurboTax by using these steps:
  • In the search box, upper right type nonbusiness bad debt  
  • Jump to nonbusiness bad debt
  • Continue to the screen Choose the type of investment you sold
  • Select Uncollectible Debt (Nonbusiness Bad Debt)
  • Continue to enter your information.  

[tagteam]

Re Section 1244, the requirements can be found at the links below.

https://www.law.cornell.edu/uscode/text/26/1244

https://www.thetaxadviser.com/issues/2009/mar/claimingordinarylossesforsec1244stock.html

[familymateu-hotm]

Thanks, but the investment was in equity not debt.

[Rick19744]

I believe everyone understands this.  However, your limited facts don't allow anyone at this point to provide an accurate response.

So @Critter-3 provides details as to the reporting if it was debt and not equity.

And @tagteam provides commentary on determining if your stock will qualify as Section 1244.

So between the two, you should be able to determine how to report.

Make sure you read the commentary, as there are reporting requirements that need to accompany the tax return other than just inputting the amount of the loss.

If your investment does qualify, it may only qualify in part, but once again, we don't have any details.

Finally, should the investment loss qualify as Section 1244, this will be reported on form 4797 and not Schedule D.

[familymateu-hotm]

Thanks for such a prompt reply. The investment was made in August 2015 and the company at the time was under $1 million in issued stock. I invested $100k . The company had the license to distribute the products in the USA of a well known European beauty company. We sued for fraud in 2018 but lost the case in 2021 due to a technicality. Any more details you may need please let me know.

[DaveF1006]

Yes, since this was strictly equity, you can write off the investment loss as a capital loss subject to the $3000 per year capital loss limitation. Be sure to have detailed documentation on hand if the IRS has questions about the loss.

Please refer to this Turbo Tax link for more details including on how to claim the loss in your Turbo Tax program. 

[familymateu-hotm]

Thanks for the info! This means I can’t offset the loss against my stock portfolio realized capital gains?

[ThomasM125]

By an equity interest I assume you mean you purchased stock in the company. If so, it may qualify for section 1244 treatment, which means the loss would be an ordinary loss, not a capital loss. In this case, you would not net it against capital gains from other investment sales, but rather you can write off the $100,000 (If you are filing married joint, only $50,000 if single) against ordinary income. 

Here are the qualifications for section 1244 small business stock:

  -  Must be stock in C or S corporation

  -  Stock is owned by individual or partnership

  -  TP must be the original owner of the shares

  -  Must be domestic corporation

  -  Must have been issued in exchange for cash or property

  -  Total capital contributions to the corporation less than $1 million at time stock issued

  -  No more than 50% of gross receipts for 5 most recent years from rents, royalties, interest, annuities, or gains on sales of stock or securities

If your transaction qualifies for section 1244 treatment, you would report it on form 4794, as mentioned by @Rick19744

As such, it would be subtracted from your other income reported on your tax return, so indirectly it would reduce any capital gain income your report.