Investing in startups comes with high hopes—and sometimes, hard losses. If your investment in a startup turns into a total loss, you might wonder what happens next on your tax return. The good news: the IRS doesn’t just leave you out in the cold. There are ways to use those losses to reduce your tax bill.
Capital Losses and How They Work
If you sell or abandon your stake in a failed startup, you’ll likely have a capital loss. Most startup investments are considered capital assets, so when you lose money, you can use that loss to offset any capital gains you have elsewhere—say, from stocks or real estate. If your capital losses exceed your gains, you can deduct up to $3,000 per year ($1,500 if married filing separately) from your ordinary income. If your loss is more than that, you can carry it forward to future years until it’s used up.
Ordinary Losses: A Special Case
Some startup investments—like those in Section 1244 stock—might qualify as an ordinary loss if the company goes out of business. This is a big deal: ordinary losses can be deducted against your ordinary income (like salary or business income), not just capital gains. For individuals, you can deduct up to $50,000 per year ($100,000 if married filing jointly) as an ordinary loss under Section 1244. But not every startup issues 1244 stock, so check your paperwork or consult a tax advisor.
Documenting Your Loss
To claim a loss, you need to show the investment is truly worthless. Usually, this means the company has been liquidated, or you’ve sold your shares for nothing. Keep records of your investment, communications on the company’s shutdown, and any liquidation paperwork. For more details, see IRS Publication 550.
Filling Out Your Tax Return
- Capital losses: Report on Schedule D of your Form 1040.
- Section 1244 ordinary losses: Also use Schedule D, but note the ordinary loss portion on Form 4797.