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First, a little background information: Several years ago I made an investment in a tax preparation business. For a one time payment, I received a small percentage of all the future income from franchise fees and royalties (tax prep fees). The deal only applied to a fixed geographic area, not the entire country. The percentage was limited to the amounts received by an entity set up to develop the geographic territory. I have received a 1099-Misc every year, with the total amounts paid to me shown in box 3. I've been paying taxes on these amounts as "other income", not "Royalties" (box 2).

Secondly, the questions: Is "other income" correct? Could the payments received have been considered a return of capital? As long as I was getting paid, I never questioned the situation. Now, there is a possibility the entity with which I contracted may either fail or be sold for only a nominal sum. Both of those outcomes would result in the loss of a portion of my initial investment, even considering all payments received to date. If that happens, how much of the loss can I take on my taxes? Is this considered to be a loss of all my initial investment?

I've tried to be brief, if there is a key bit of information missing, please let me know.

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