Dear Tax Talk,
Writing off a bad business investment
Two years ago I invested $20,000 in a small
business my friend started (either as a corporation or S corporation).
I was issued shares in exchange for the money I invested. For
the last two to three months the business stopped operating,
and his whereabouts are unknown. Is there a tax write-off I
can use? Can I consider the investment as a capital loss?
It's a shame you lost your friend and worse yet the $20,000.
It would be helpful if you could find the accountant
that the friend was using to figure out if tax returns were
done. As a shareholder of the company, you could call the
Internal Revenue Service if you have the tax ID number of
the business and find out if it is a conventional corporation
or if it made an S election.
If it made an S election and no tax return was
done, it would probably be a good idea to do the return so
that you can claim some or all of your loss as an ordinary
loss that flows to your individual return. Depending on your
percentage of ownership in the company, some or all of the
$20,000 could be an ordinary loss from an S corporation that
could be offset against your other income.
If there is no S election, you may still be
able to claim an ordinary loss from what's called Section
1244 loss. Section 1244 stock is stock that is originally
issued by a company (as opposed to being acquired from another
person) in exchange for cash. This sounds like your situation.
If you put the full $20,000 in at once in exchange
for the stock, then it's likely the stock loss would qualify
for Section 1244 treatment. If you put in only $5,000 for
the stock you originally received and later put in another
$15,000 as additional capital without receiving stock, then
only $5,000 of the $20,000 would qualify for Section 1244
treatment, the remainder would be capital loss.
The company had to be an operating company and
not an investment company, meaning that it can't receive more
than 50 percent of its income from rents, dividends and interest.
Report a section 1244 loss on Form
Publication 550 discusses Section 1244 loss.
-- Posted: Jan. 11 2005