Ordinarily, a loss on a sale or exchange of stock is a capital loss. Capital loss treatment is generally less advantageous than ordinary deduction treatment because of the fact that a capital loss recognized by an individual is applied, first against capital gain (which is usually subject to tax at a maximum marginal rate which is lower than that on ordinary income), and, to the extent it exceeds capital gains recognized during the year, is subject to limitations on deductibility.

Fortunately, the tax law allows ordinary loss treatment on certain losses with respect to stock of small corporations. In general, this special treatment is only available if the following conditions are satisfied:

 (1) As of the time the stock was issued, the aggregate amount that was received by the issuing corporation for stock, as contributions to capital and as paid-in surplus, must not have exceeded $1 million.

 (2) The stock must have been issued for money or property (other than stock or securities). Thus, the stock can’t be issued as compensation for services.

 (3) For the five years before the year the loss was sustained, the corporation must not have received 50% or more of its receipts from certain passive sources.

 (4) The taxpayer claiming the special treatment must be an individual (including, if certain conditions are satisfied, individuals who claim the loss through holding an interest in a partnership that is selling the stock). The special treatment isn’t available to corporations, trusts or estates.

 (5) The stock must have been issued to the individual claiming the special treatment, or to the partnership through which the individual is claiming the special treatment, and held continuously by that individual (or partnership) to the time of sale.

In any year, the total loss treated as ordinary under these rules can’t be more than $50,000 (or $100,000 if you file a joint return).