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Section 1045 of the tax code defines how to perform a qualified rollover of Qualified Small Business Stock, or QSBS.
- A business must meet three qualifications to be considered a Qualified Small Business.
- The business must be a domestic C corporation.
- The business must not surpass, nor have ever surpassed a $50M gross-asset test.
- The business must be actively engaged in a “qualified trade or business,” which can be crudely summarized to mean a product-based business rather than a service-based business.
- In order for the stock you own in this company to benefit from the tax exemptions you must
- have held the stock for at least 5 years*
- have purchased the stock directly from the company.
*Read below to see how a 1045 Exchange affects this stipulation.
If all of the above criteria are met, section 1202 of the tax code offers the shareholder the following benefits in regards to the capital gains resulting from the sale of this stock.
- The shareholder can exclude a certain percentage of the capital gains incurred from the sale of eligible QSB stock up to $10M or 10x the adjusted cost basis of the stock.
- 50% of capital gains can be excluded from QSBS purchased after August 11, 1993.
- 75% of capital gains can be excluded from QSBS purchased between February 18, 2009 and September 27, 2010.
- 100% of capital gains can be excluded from QSBS purchased after September 27, 2010.
While typical long-term capital gains rates can be claimed after only one year, the 5-year holding period for QSBS may be a turn off to some investors.
This Is Where Section 1045 Comes Into Play.
Section 1045 lays out the process for the exchange of one QSBS for another QSBS, allowing the 5 year holding period to be satisfied in a second qualified small business. The start date of the holding period remains the date on which the stock in the original qualified small business was acquired.
Once a shareholder owns qualified small business stock for 6 months, he or she may sell that stock and defer the capital gains by reinvesting the entirety of the gains into another qualified small business. The investor has 60 days from when the stock is sold to perform the rollover. The company issuing the new stock must remain eligible for QSB status for 6 months after the acquisition of this new stock in order for the investment to maintain its status as QSBS.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.