Problem 48 – LO.

6,7 Three years ago at a cost of $40,000, Paul Sanders acquired stock in a corporation
that qualified as a small business corporation under § 1244. A few months after he acquired the stock,
when it was still worth $40,000, he gave it to his brother, Mike Sanders. Mike, who is married and files
a joint return, sells the stock for $25,000 in the current tax year. Mike asks you, his tax adviser, how the
sale will be treated for tax purposes. Prepare a letter to your client and a memo for the file. Mike’s
address is 10 Hunt Wood Drive, Hadley, PA 16130.

*Section 1244 Stock permits ordinary loss treatment for losses on sale or worthlessness of stock. Gains
on sale of Section 1244 stock remains capital. NOTE: The ordinary loss deduction limit in any one year
from the disposition of Section 1244 stock is $50K (or $100K for MFJ). Any loss sustained in the taxable
year exceeding the limit is considered a capital loss.

Mike Sanders

10 Hunt Wood Drive

Hadley, PA 16130

Dear Mike,

This letter is in response to your question regarding the Section 1244 Stock ($40000) that your brother
transferred to you and that you have sold at $25000. Even though Section 1244 permits ordinary loss
treatment (for losses on the sale or worthlessness of stock), only the original holder of Section 1244
Stock is qualified for the ordinary loss treatment.

The basis of the stock received from your brother is $40K (value at time of transfer). Because you sold it
at a $15K loss ($40K - $25K), you can recognize this sale of this stock as capital loss. You may deduct up
to $3K per year on your tax return and can carry any excess loss forward until the $15K runs out.

Best,

Janet Mark

MEMORANDUM: Mike is not qualified for Section 1244 Stock’s ordinary loss treatment because he is not
the original holder. Mike can claim capital loss instead.