At a Glance
Section 1202 provides a potential tax benefit for investors who sell qualifying small business stock, also known as qualified small business stock (QSBS). For stock acquired after July 4, 2025, investors may qualify for a partial gain exclusion after three or four years of ownership, or a full exclusion after five years.
The expanded rules also increase the gain-exclusion cap and raise the gross-assets threshold a corporation may meet while still qualifying as a small business for these purposes.
Key Takeaways
- For qualifying stock acquired after July 4, 2025, investors may exclude 50% of gain after a three-year holding period, 75% after four years, and 100% after five years.
- The lifetime gain-exclusion cap increases from $10 million to $15 million for qualifying stock acquired after July 4, 2025, and will be indexed annually for inflation.
- The corporate gross-assets ceiling increases from $50 million to $75 million.
- To qualify, stock must be issued directly by a domestic C corporation that operates an active trade or business.
- Entity selection can be an important consideration because these benefits are available only for C corporation stock.
Who Is Affected
These changes may affect:
- Individuals investing in qualifying small businesses
- Shareholders considering the sale of stock in a domestic C corporation
- Founders and owners of growing businesses considering entity structure
- New companies evaluating whether C corporation status may offer future tax advantages to investors
Eligibility and Key Requirements
Eligibility Requirements
To qualify as QSBS, the stock must meet the following requirements:
- The stock must be issued by an entity taxed as a domestic C corporation
- The shareholder must acquire the stock directly from the corporation
- The corporation must be engaged in an active trade or business when the stock is acquired
- The corporation’s aggregate gross assets cannot exceed the applicable gross-assets ceiling
- The shareholder must meet the applicable holding-period requirements to claim a gain exclusion
Limits, Thresholds, and Phaseouts
For qualifying stock acquired after July 4, 2025, the available gain exclusion depends on the shareholder’s holding period:
- Three years: 50% of gain may be excluded
- Four years: 75% of gain may be excluded
- Five years or more: 100% of gain may be excluded
The gain-exclusion cap increases to $15 million for qualifying stock acquired after July 4, 2025. This amount will be indexed annually for inflation.
The exclusion may also be determined based on 10 times the adjusted basis of the stock sold during the year.
The corporate gross-assets ceiling increases from $50 million to $75 million.
Exclusions and Special Rules
The enhanced holding-period, gain-exclusion cap, and gross-assets provisions apply to stock acquired after July 4, 2025.
The Section 1202 gain exclusion is limited to stock in domestic C corporations. Stock in other entity types does not qualify under the requirements described in the article.
Before these changes, the Section 1202 benefit generally required a five-year holding period. Investors who sold qualifying stock before the five-year period ended were not eligible for the gain exclusion.
Documentation and Reporting
The article does not specify particular reporting requirements. Investors should retain records supporting:
- The date the stock was acquired
- The method of acquisition, including confirmation that it was issued directly by the corporation
- The corporation’s status as a domestic C corporation
- The corporation’s gross assets when the stock was acquired
- The corporation’s active trade or business
- The shareholder’s adjusted basis, holding period, and gain on sale
Effective Dates
The enhanced Section 1202 benefits apply to stock acquired after July 4, 2025.
For qualifying stock acquired after that date:
- A 50% gain exclusion may be available after three years
- A 75% gain exclusion may be available after four years
- A 100% gain exclusion may be available after five years
The increased $15 million gain-exclusion cap and $75 million gross-assets ceiling also apply to qualifying stock acquired after July 4, 2025.
Planning Considerations
Investors considering an investment in a small business should evaluate whether the company is organized and taxed as a domestic C corporation and whether the stock will be issued directly by the corporation.
Because the available gain exclusion depends on the holding period, investors should consider the anticipated timing of a future sale. Holding qualifying stock for at least three years may provide a partial exclusion, while holding it for five years may provide a full exclusion.
Businesses and founders evaluating entity structure should consider the potential future value of Section 1202 to investors. The availability of a gain exclusion may make C corporation stock more attractive in certain circumstances.
Businesses approaching the $75 million gross-assets threshold should also evaluate the timing of investments, stock issuances, and other transactions that may affect eligibility.
Example
An investor acquires stock directly from a domestic C corporation after July 4, 2025. At the time of the investment, the corporation is engaged in an active trade or business and has aggregate gross assets below $75 million.
If the investor sells the qualifying stock after three years, the investor may be eligible to exclude 50% of the gain. If the investor holds the stock for five years or more, the investor may be eligible to exclude 100% of the gain, subject to the applicable gain-exclusion limits.
In contrast, stock in an entity that is not taxed as a domestic C corporation would not qualify for these Section 1202 benefits.
Next Steps
- Review whether the business is taxed as a domestic C corporation and whether its stock may qualify as QSBS.
- Confirm the corporation’s gross assets and active trade or business status when stock is issued.
- Retain records supporting stock issuance, acquisition date, adjusted basis, and holding period.
- Consider the potential Section 1202 benefits when evaluating investment, sale, and entity-structure decisions.
For additional information about qualified small business stock and Section 1202 planning, contact your RKL advisor.
Frequently Asked Questions
Who may qualify for the Section 1202 gain exclusion?
Individuals holding qualifying stock issued directly by a domestic C corporation may qualify if the corporation meets the active trade or business and gross-assets requirements, and the shareholder meets the applicable holding-period requirements.
What is the maximum gain exclusion?
For qualifying stock acquired after July 4, 2025, the gain-exclusion cap is $15 million and will be indexed annually for inflation. The exclusion may also be based on 10 times the adjusted basis of the stock sold during the year.
When do the expanded benefits apply?
The enhanced benefits apply to qualifying stock acquired after July 4, 2025.
How long must stock be held?
For qualifying stock acquired after July 4, 2025, a shareholder may qualify for a 50% exclusion after three years, a 75% exclusion after four years, and a 100% exclusion after five years.
What businesses do not qualify?
The gain exclusion applies only to stock in a domestic C corporation. Businesses organized or taxed as another entity type do not qualify under the requirements described in the article.
