IRC Section 1202 QSBS Exclusion: Limits, Holding Period, Rollover

The IRC Section 1202 QSBS exclusion lets a non-corporate taxpayer exclude up to 100% of the gain from selling qualified small business stock, subject to a per-issuer cap that is the greater of $15 million (for stock acquired after July 4, 2025) or ten times your original basis. Whether you reach the full exclusion depends on the company’s size and business activities, how you acquired the shares, how long you held them, and when the stock was issued. The One Big Beautiful Bill Act, signed on July 4, 2025, rewrote several of those rules, so the answer now depends on which side of that date your stock falls on.

What Qualifies as QSBS

The company must be a domestic C-corporation. S-corporations, partnerships, LLCs taxed as partnerships, REITs, regulated investment companies, and cooperatives are all excluded.¹ “Domestic” means organized in the United States or under U.S. law.

You must acquire the stock at original issuance, either directly from the company or through an underwriter. Acceptable payment is cash, property (other than stock), or services performed for the corporation. Buying shares on a secondary market from another shareholder disqualifies the stock.¹

The Aggregate Gross Asset Ceiling

The corporation must fit under a size cap at issuance. For stock issued on or before July 4, 2025, the company’s total cash plus the adjusted tax basis of all its other property could not exceed $50 million at any time before and immediately after the issuance. For stock issued after July 4, 2025, the threshold is $75 million, with inflation adjustments beginning in 2027.² Stock that qualified at issuance keeps its status even if the company later grows past the ceiling.

The Active Business Test

At least 80% of the corporation’s assets, by value, must be used in a qualified trade or business, and that has to hold for substantially all of the time you own the stock. Parking too much money in passive investments or unrelated real estate can fail this test and disqualify all outstanding QSBS.¹

Certain industries are excluded outright, no matter how actively they operate:²

Professional services: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, and financial or brokerage services
Financial businesses: banking, insurance, financing, leasing, or investing
Farming, including raising or harvesting trees
Natural resource extraction: mining, oil, gas, and similar
Hotels, motels, and restaurants
Any business whose principal asset is the reputation or skill of one or more employees

Startups often sit on large cash balances after a funding round. The statute treats cash and investments earmarked for research, experimentation, or working capital as active business assets if the company reasonably expects to deploy them within two years. Once a corporation has existed for at least two years, no more than 50% of its assets can rely on this safe harbor.²

Who Can Claim the Exclusion

Only non-corporate taxpayers qualify. That includes individuals, trusts, and estates. A corporation that invests in another corporation gets no Section 1202 benefit.¹

If you hold QSBS through a partnership or LLC, you can still take the exclusion on your individual return, but only if you held your interest in the entity on the date it acquired the stock and continuously after that. Buying into a partnership that already owns QSBS does not let you piggyback on the exclusion.²

How Much You Can Exclude

The exclusion percentage and the required holding period both depend on when the stock was originally acquired. Two frameworks apply, split by July 4, 2025.

Stock Acquired On or Before July 4, 2025

You must hold the shares for more than five years to claim anything. The percentage depends on when the stock was acquired:³

August 10, 1993 through February 17, 2009: 50% exclusion
February 18, 2009 through September 27, 2010: 75% exclusion
September 28, 2010 through July 4, 2025: 100% exclusion¹

Selling before the five-year mark under this regime yields no exclusion at all. The full gain is taxed at standard capital gains rates.

Stock Acquired After July 4, 2025

The OBBBA added a graduated schedule that lets you claim something starting at three years:²

Held at least 3 years: 50% exclusion
Held at least 4 years: 75% exclusion
Held at least 5 years: 100% exclusion

The three-year and four-year tiers are new. Under the old rules, a sale at four years and eleven months meant zero exclusion; under the new rules for post-July 4, 2025 stock, that same sale delivers a 75% exclusion.

The Per-Issuer Gain Cap

The exclusion has a ceiling per company. For stock acquired on or before July 4, 2025, the maximum excludable gain per issuer is the greater of $10 million or ten times your adjusted basis in the stock. For stock acquired after July 4, 2025, the cap rises to the greater of $15 million or ten times your basis, with inflation adjustments beginning in 2027.²

The cap is per issuer, not per transaction. Sell QSBS in Company A across two years and both sales draw on the same ceiling. Gains from Company B have their own separate cap. Anything above the ceiling is taxed normally.

For married couples filing jointly, each spouse is treated as a separate taxpayer, so both can potentially claim the full per-issuer cap on stock they individually own. Filing separately cuts each spouse’s cap in half. The IRS has not issued definitive guidance confirming the joint-ownership approach in every scenario.

Tax on the Non-Excluded Portion and AMT

When the exclusion is less than 100%, the remaining taxable gain is subject to a 28% capital gains rate rather than the standard 15% or 20% rate. This applies to the 50% and 75% tiers under both regimes. If you acquired stock in 2000 and exclude 50% of a $5 million gain, the remaining $2.5 million is taxed at 28%.

The same 28% rate applies under the new OBBBA schedule when you sell post-July 4, 2025 stock after three or four years. Only at the five-year mark, where the exclusion is 100%, does the rate become irrelevant.

For the 50% and 75% tiers, 7% of the excluded gain is treated as an alternative minimum tax preference item and added back to income when calculating AMT.⁴ At the 100% exclusion, whether under the pre-OBBBA September 28, 2010 through July 4, 2025 window or under the post-OBBBA five-year tier, the excluded gain is completely exempt from AMT.

Redemption Traps That Can Disqualify Your Shares

If the corporation buys back a meaningful amount of its own stock around the time your shares were issued, your stock can lose its qualified status even though you did nothing wrong. Two separate tests apply, and failing either is fatal:⁵

Targeted redemptions: Your stock is disqualified if, during a four-year window starting two years before your shares were issued, the corporation repurchased more than 2% of the stock held by you or your related parties and paid more than $10,000 for it.
Significant redemptions: Even if the buyback had nothing to do with you personally, your stock is disqualified if, during a two-year window starting one year before your issuance, the corporation repurchased stock worth more than 5% of the total value of all outstanding shares (subject to the same $10,000 and 2% minimums).

Founders and early employees should watch for this when the company buys out a departing co-founder or repurchases unvested shares. Those transactions can inadvertently taint stock issued to other investors during the overlapping window.

Holding Period Tacking and Entity Conversions

Receive QSBS as a gift or inherit it at death and you generally inherit the prior owner’s holding period and original-issuance status. The same rule applies when a partnership distributes QSBS to a partner. In each case the clock does not restart.² When tacking applies, the transferee also takes the transferor’s acquisition date for determining which set of Section 1202 rules governs. So if you inherit stock from someone who acquired it before July 4, 2025, the pre-OBBBA rules apply to you.

Many startups begin as LLCs or partnerships and later convert to C-corporations specifically to issue QSBS. When you transfer property (other than cash or stock) to a corporation in exchange for shares, the stock’s basis is set at no less than the property’s fair market value at the exchange, and the holding period starts on the exchange date, not the date the LLC was formed.² Years spent operating as an LLC do not count. The clock starts fresh at conversion.

If a partnership already owns QSBS and distributes it to a partner, the treatment is more favorable. The partner is treated as having acquired the stock the same way the partnership did and inherits its holding period, provided the partner held the partnership interest when the entity originally acquired the stock.²

Deferring Gain With a Section 1045 Rollover

Selling QSBS before you qualify for the Section 1202 exclusion is not necessarily the end of the story. Section 1045 lets you defer the gain if you held the stock more than six months and reinvest the proceeds into new QSBS within 60 days of the sale.⁶ Gain is recognized only to the extent proceeds exceed the amount reinvested.⁷

The replacement stock takes a reduced basis (your original basis carries over, adjusted for any recognized gain), and the old holding period tacks onto the new stock for purposes of reaching the Section 1202 exclusion. To elect, report the full gain on Schedule D, write “section 1045 rollover” below the line, and enter the deferred gain as a loss on the same line.⁷

The 60-day window is strict. Missing it by a day makes the entire gain taxable in the year of sale.

State Income Taxes

Section 1202 is a federal exclusion, and not every state conforms. California does not follow Section 1202 and taxes QSBS gain in full at its standard rates; the top California capital gains rate is 13.3%, meaning an investor there who excludes $10 million federally could still owe over $1.3 million in state tax. Alabama, Mississippi, and Pennsylvania also fully or partially decouple, with top rates ranging from roughly 3% to over 5%.

Most states do conform, so the federally excluded gain is also excluded at the state level. Conformity rules change, so confirm your state’s current treatment before assuming the gain is entirely tax-free. This matters especially for founders considering relocation before a sale.

Documentation to Keep

Section 1202 claims depend on records most investors do not think to collect until it is too late. Start assembling these well before any sale:

The exact date you received shares at original issuance, not the date of any prior agreement
The sale date
Cost basis: the amount paid, or the fair market value of property or services exchanged for the shares
Written confirmation from the corporation that its aggregate gross assets did not exceed $50 million (or $75 million for post-July 4, 2025 issuances) at the time of issuance
Documentation that the corporation met the 80% active business requirement for substantially all of the period you held the stock

The statute requires the corporation to agree to file reports with the IRS and shareholders as the IRS may require.² Many small companies do not proactively prepare QSBS certification letters. Ask for them at issuance and again before a sale. Reconstructing this evidence years after an acquisition or dissolution can be very difficult.

Reporting the Exclusion on Your Return

The exclusion is reported on IRS Form 8949, which feeds Schedule D of your Form 1040:⁸

Report the full sale on Form 8949 as though you were not taking the exclusion, entering description, acquisition date, sale date, proceeds, and cost basis in the standard columns.
Enter code “Q” in column (f) to flag the transaction as a Section 1202 exclusion.
Enter the excluded gain as a negative number in column (g) to reduce the taxable portion.
Transfer the totals to Schedule D, where the net gain after exclusion flows into your overall capital gains calculation.

Both forms are filed with your Form 1040 for the year of the sale. For installment sales, the exclusion interacts with the installment reporting rules on Schedule D rather than being reported entirely in the year of sale. Omitting the “Q” code or the negative adjustment in column (g) causes the IRS to treat the full gain as taxable, and correcting it requires an amended return.⁸

1
Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock
2
Office of the Law Revision Counsel. 26 US Code 1202 – Partial Exclusion for Gain From Certain Small Business Stock
3
U.S. Department of the Treasury. Quantifying the 100% Exclusion of Capital Gains on Small Business Stock
4
The Tax Adviser. Sec 1202 Small Business Stock Capital Gains Exclusion
5
eCFR. 26 CFR 1.1202-2 – Qualified Small Business Stock
6
Office of the Law Revision Counsel. 26 USC 1045 – Rollover of Gain From Qualified Small Business Stock to Another Qualified Small Business Stock
7
Internal Revenue Service. Revenue Procedure 98-48
8
Internal Revenue Service. Instructions for Form 8949