Section 1202 lets a founder or investor exclude up to 100% of the federal capital gain on a sale of qualified small business stock (QSBS), subject to a per-issuer cap. On a single exit, that exclusion can reach into the millions.
The QSBS rules are strict. Stock that misses a single requirement loses the exclusion, and several defects cannot be fixed after the shares are issued. Before a liquidity event, review the five core requirements, the per-issuer cap, and the events that can disqualify stock while you still have time to address problems.
Your stock qualifies for the Section 1202 exclusion only if it meets all five requirements:
The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, changed three of these rules. The higher gross-asset threshold applies to stock issued after July 4, 2025. The tiered holding-period schedule and the higher per-issuer cap apply to stock acquired after July 4, 2025. For newly issued founder and investor shares, those dates usually line up.
Section 1202 applies only to stock issued by a domestic C corporation. Interests in an S corporation, LLC, partnership, or foreign entity do not qualify, and S corporation stock issued before a conversion remains ineligible after the company becomes a C corporation.
An LLC that incorporates can create QSBS in the conversion itself. Stock issued in exchange for the LLC’s property can qualify, but the holding period starts on the conversion date, and gain that built up before the conversion remains taxable because the stock’s basis for Section 1202 purposes is no less than the property’s fair market value. An S corporation that converts can issue QSBS only on shares issued afterward. In either case, the conversion must be structured correctly. Learn how conversion timing affects QSBS status in our post on converting an S corp to a C corp for QSBS.
The corporation’s aggregate gross assets must not exceed the applicable threshold at any time before your stock is issued, and they must stay under it immediately after issuance, counting the proceeds of that issuance. A corporation that crossed the threshold before you received your shares cannot issue you QSBS, and no later step cures that defect.
The gross-asset threshold is $50 million.
The OBBBA raised the threshold to $75 million. The $75 million figure is indexed for inflation for taxable years beginning after 2026.
Aggregate gross assets equal the corporation’s cash plus the adjusted basis of its other property. Property contributed to the corporation counts at its fair market value at the time of contribution. Liabilities do not reduce the total. The test also counts the assets of any predecessor corporation, and a parent corporation and any subsidiary in which it holds more than 50% of the stock are treated as one corporation.
Because the test uses adjusted basis rather than market value, a company’s valuation can far exceed its gross assets for purposes of this test. Cash from funding rounds and contributions of high-value property count in full. If you are uncertain whether the company passed the gross-asset test when your shares were issued, request a written gross-asset calculation. Revenue and headcount are poor substitutes.
The test looks only at the period before and immediately after issuance. Later growth in assets or valuation does not affect shares issued while the company was under the threshold. Once the company crosses it, the company can no longer issue new QSBS.
Section 1202 requires that you acquire the stock at its original issuance, directly from the corporation, in exchange for money, property other than stock, or services provided to the corporation. Stock purchased from another shareholder, including in a private transaction, does not qualify.
This requirement catches investors who assume that buying into an early-stage company is enough to secure QSBS status.
Section 1202(h) lets certain transferees step into the original holder’s position. Stock received by gift, at death, or in a qualifying distribution from a partnership to a partner keeps its QSBS character, and the recipient generally takes over the transferor’s holding period. Each path carries its own conditions, so confirm your status in writing before you assume the exclusion applies.
We cover common pitfalls in our post on the QSBS original issuance requirement.
At least 80% of the corporation’s assets, by value, must be used in the active conduct of one or more qualified trades or businesses during substantially all of your holding period. The statute does not define “substantially all,” so a company that falls out of compliance for part of your holding period puts your exclusion at risk.
The test depends on how the company holds and uses its assets. A corporation that holds large amounts of investment securities, cash beyond its working-capital needs, or real estate not used in the business may fall below the 80% threshold even while it operates in a qualified field. Section 1202(e) sets specific limits on each of these categories, and a company near those limits needs a documented asset-by-value analysis.
Section 1202(e)(3) excludes these businesses from the definition of a qualified trade or business:
If your company operates in an excluded field, even in part, confirm with counsel how the 80% asset test applies to your structure.
The percentage of gain you can exclude depends on when you acquired your stock and how long you held it before the sale. Section 1202 sets the acquisition date after applying the holding-period rules of Section 1223, so stock received by gift or in certain exchanges can carry an earlier acquisition date.
You must hold the stock for more than five years. Stock acquired after September 27, 2010, qualifies for a 100% exclusion at that point. Stock acquired earlier qualifies for a 50% or 75% exclusion, depending on the acquisition date. A sale after five years or less produces no exclusion under the prior rules.
The OBBBA added a tiered schedule.
| Holding Period | Exclusion |
|---|---|
| At least 3 years, less than 4 | 50% |
| At least 4 years, less than 5 | 75% |
| 5 years or more | 100% |
The governing schedule depends on the exact acquisition date, and the gap between tiers can be substantial on a large exit. If you are approaching a liquidity event and are unsure which rules apply to your shares, speak with a tax attorney before you close.
Section 1202 limits the gain each taxpayer can exclude from the stock of a single issuer. The cap is the greater of a dollar limit or 10 times the taxpayer’s aggregate adjusted basis in the QSBS of that issuer sold during the year.
The cap applies per taxpayer, per issuer, and each issuer carries its own cap. That structure can support QSBS stacking strategies, in which qualifying shares are held by multiple taxpayers, such as family members or certain trusts, and each taxpayer may apply a separate exclusion subject to the Section 1202 rules. Married taxpayers face special rules under Section 1202(b)(3), including a halved cap on separate returns and equal allocation of excluded gain between spouses on a joint return.
Stock can fail the QSBS rules because of events after issuance, and certain redemptions reach back before it. Review these issues before a sale.
Section 1202 requires the issuer to remain a C corporation during substantially all of your holding period. An S election or a reorganization into a pass-through entity after you acquire your shares can put QSBS status at risk. Some reorganizations preserve QSBS treatment, and others do not, so analyze any restructuring with counsel before it occurs.
If the company moves its primary operations into an excluded field after you acquire your shares, it may fail the active-business requirement for part of your holding period. Review the company’s current operations against the excluded list above and confirm status with counsel if there is any question.
Section 1202(c)(3) disqualifies stock if the corporation buys back stock from you or a related person during the four-year window that begins two years before your shares are issued. Stock also fails if, during the two-year window that begins one year before issuance, the corporation buys back more than 5% of the total value of its stock. Treasury regulations provide limited de minimis exceptions, so review any planned buyback against these windows before it closes.
Once eligibility is confirmed, three related strategies often come into play.
For a full overview of Section 1202, visit our QSBS hub page, or browse all topics in our QSBS article library.
No. Section 1202 applies only to stock issued by a domestic C corporation. An LLC or S corporation that converts to a C corporation can issue QSBS after the conversion. S corporation shares issued before the conversion remain ineligible.
It depends on when you acquired the stock. Stock acquired after July 4, 2025, can qualify for a 50% exclusion after three years and a 75% exclusion after four years. Stock acquired on or before that date produces no exclusion if sold after five years or less, although a Section 1045 rollover may let you defer the gain.
The cap is the greater of a dollar limit or 10 times your adjusted basis in that issuer’s stock sold during the year. The dollar limit is $10 million for stock acquired on or before July 4, 2025, and $15 million for stock acquired after that date.
If you are a founder or investor approaching a liquidity event, the time to confirm QSBS status is before the deal closes. Allegis Law helps founders and startup investors analyze Section 1202 eligibility, structure for the exclusion, and coordinate with financial advisors on exit planning.
Call (801) 938-4035 or request a consultation online.
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