Sale of S stock generates ordinary income.

• Author: Botkin, Jeffri
• Position: Brief Article

Gain on the sale of S stock generally is characterized by the shareholder as a capital gain if the S stock is held as a capital asset by the selling shareholder. However, sale of stock in an S corporation that has deducted intangible drilling and development costs (IDC), mining development and exploration expenditures, and depletion may result in ordinary income treatment.

Prop. Regs. Sec. 1.1254-4 provides that on the sale or exchange of S stock, a selling shareholder recognizes ordinary gain to the extent of that shareholder's Sec. 1254 costs (with respect to the shares sold or exchanged). The ordinary gain portion is the selling shareholder's pro rata share of the recapture that would be recognized if, immediately before the S stock sale, the corporation had sold at fair market value (FMV) all of the corporations property that would generate income from IDC and depletion recapture.

Prop. Regs. Sec. 1.1254-4(c) provides an exception to the general rule, allowing capital gain treatment on the portion of gain not attributable to Sec. 1254 costs. The selling shareholder must establish and substantiate the capital gain treatment by attaching a...