Section 1202 Exclusion: Eligibility, Gain Cap, and Rollover

The Section 1202 QSBS exclusion lets non-corporate taxpayers exclude up to 100% of the capital gain from selling qualified small business stock, subject to a per-issuer cap of $10 million or $15 million (or ten times your adjusted basis, whichever is greater). Whether you get the full exclusion depends on when the corporation issued the stock, how long you held it, what the company does, and how big it was when your shares were issued. The rules changed meaningfully in July 2025, so the answer now depends heavily on your issuance date.

What Changed in July 2025

The One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, rewrote several of the core numbers in Section 1202. The new rules apply only to stock issued after July 4, 2025. Shares issued on or before that date still follow the older regime, which means a single company can have shareholders sitting under different caps, thresholds, and holding schedules at the same time.

For stock issued after July 4, 2025:

The per-issuer gain cap rose from $10 million to $15 million, with inflation adjustments beginning in tax years after 2026.
The company’s aggregate gross assets limit rose from $50 million to $75 million, with inflation adjustments beginning in 2027.¹
A tiered holding schedule replaced the all-or-nothing five-year rule: 50% exclusion after three years, 75% after four, 100% after five.
The partial exclusions at three and four years do not trigger an alternative minimum tax preference.

Who Can Claim the Exclusion

Section 1202 is only for non-corporate taxpayers. Individuals, trusts, estates, and pass-through entities like partnerships and S-corporations can claim it. A C-corporation that sells stock in another company cannot.²

You must have acquired the stock directly from the issuing corporation in exchange for money, property, or services. Buying shares on a secondary market or from another shareholder disqualifies you. The point of the rule is that your capital reached the company itself.²

Three narrow exceptions preserve QSBS status without a direct purchase: gifts, transfers at death, and spousal transfers under a divorce settlement. In each case, the recipient inherits the original holder’s acquisition date, so the holding period keeps running rather than restarting. Because the gain cap applies per taxpayer per issuer, gifting QSBS to family members can multiply the total exclusion available across a household.

Which Companies Qualify

The issuer has to be a domestic C-corporation that passes both a size test and an active-business test. Stock issued by an S-corporation, LLC, or foreign corporation does not qualify. If an entity converts to a domestic C-corporation, only stock issued after the conversion counts.

The Size Test

From the corporation’s formation through the moment immediately after your stock is issued, the company’s aggregate gross assets cannot exceed $50 million (for pre-OBBBA stock) or $75 million (for stock issued after July 4, 2025). “Aggregate gross assets” means cash plus the adjusted tax basis of other property, not fair market value.²

The test is locked at the moment of issuance. If the company later grows past the threshold, your stock stays qualified. A startup worth $40 million when it issued your shares can become a billion-dollar company without affecting your exclusion.

The Active-Business Test

At least 80% of the corporation’s assets must be actively used in a qualified trade or business during substantially all of your holding period. Cash and working capital count as active assets for up to two years after issuance if they are earmarked for specific business uses like research or expansion. Idle cash beyond that window can drop the company below the 80% line and break the test.²

Industries That Are Excluded

Some businesses fail no matter how well they meet the size and active-business tests. The statute excludes:

Health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services, along with any business whose principal asset is the reputation or skill of one or more employees.
Banking, insurance, financing, leasing, and investing.
Farming (including timber) and mining or oil and gas extraction.
Hotels, motels, and restaurants.²

How Much of the Gain You Can Exclude

The exclusion percentage depends on when the corporation issued the stock. All pre-OBBBA tiers require a holding period of more than five years.

Issued August 11, 1993 through February 17, 2009: 50% excluded. The taxable half is taxed at a maximum federal rate of 28%.
Issued February 18, 2009 through September 27, 2010: 75% excluded.
Issued after September 27, 2010 and on or before July 4, 2025: 100% excluded.²

For stock issued after July 4, 2025, the tiered schedule applies:

Held at least three years but less than four: 50% excluded.
Held at least four years but less than five: 75% excluded.
Held five years or more: 100% excluded.

Any non-excluded portion is still taxed at a maximum federal capital gains rate of 28%.

The Per-Issuer Gain Cap

Your excludable gain from any single corporation is capped at the greater of the applicable dollar limit or ten times the adjusted basis of the stock you sold. The dollar limit is $10 million for pre-OBBBA stock and $15 million for post-OBBBA stock. The cap is cumulative over your lifetime for that issuer, not annual.³

The ten-times-basis alternative matters most for larger initial investments. If you put $2 million into a pre-OBBBA startup, your cap is $20 million rather than $10 million. Because the cap applies per taxpayer per issuer, spouses filing jointly each get their own cap if both individually own qualifying stock.

Stock Redemptions That Can Silently Disqualify You

Buybacks by the issuing corporation can retroactively kill QSBS status even when every other rule is met. Two tests apply, and failing either one is fatal.

The first test covers buybacks from you or a related party. If the corporation repurchases more than a de minimis amount of its stock from you or someone related to you within a four-year window centered on your issuance date (two years before through two years after), your shares lose QSBS status. “De minimis” here means the buyback exceeded both $10,000 and 2% of the stock held by you and related parties.⁴

The second test covers larger buybacks from anyone. If the corporation buys back more than 5% of the total value of its outstanding stock from any shareholder during a two-year window starting one year before your issuance date, your shares are disqualified, subject to the same de minimis floor.⁴

These windows run from each shareholder’s own issuance date, so a redemption that is safe for one shareholder can disqualify another. Ask the company about any buyback history before you count on the exclusion.

Selling Before Five Years: The Section 1045 Rollover

If you need to sell QSBS before hitting the five-year mark, Section 1045 lets you defer the gain by reinvesting the proceeds into new QSBS within 60 days. You must have held the original stock for at least six months.⁵

You can reinvest partially. If your gain is $7 million and you roll $5 million into new qualifying stock, you defer $5 million and recognize $2 million now. The replacement stock inherits the original holding period and basis, so your clock keeps ticking toward the five-year mark for a full Section 1202 exclusion later.

AMT and Net Investment Income Tax

Stock issued after September 27, 2010 and on or before July 4, 2025 that qualifies for the 100% exclusion is exempt from both the alternative minimum tax and the 3.8% net investment income tax on the excluded gain. That is the cleanest result: zero federal tax on the excluded portion.

For QSBS issued before September 28, 2010, 7% of the excluded gain is added back as an AMT preference item, and the non-excluded portion is subject to the 3.8% NIIT. Post-OBBBA stock avoids the AMT add-back even at the 50% and 75% partial tiers, but the non-excluded portion still carries the NIIT and the 28% maximum capital gains rate.

State Taxes May Still Apply

Section 1202 is a federal provision, and several states with income taxes do not follow it. California is the most notable, taxing the full gain at rates up to 13.3%. Pennsylvania, Alabama, Mississippi, and the District of Columbia also do not conform. Oregon decoupled from the federal exclusion starting in 2026. In non-conforming states, you can owe substantial state tax even when the federal bill is zero, so factor the state liability into any sale planning.

Reporting the Exclusion and Keeping Records

Report the sale on Form 8949 with the acquisition date, sale date, proceeds, and cost basis, then enter code “Q” in the adjustment column to flag it as a QSBS exclusion. The excluded portion goes in column (g) as a negative number. The adjusted figures flow to Schedule D of Form 1040.⁶

Keep the documents that prove each element: the original stock purchase agreement showing direct issuance from the corporation, the company’s financial statements confirming that aggregate gross assets stayed under the applicable threshold at issuance, and evidence that the 80% active-business test was met throughout your holding period. Large exclusions attract IRS attention, and reconstructing corporate records years after the fact is far harder than gathering them before you file.

1
The Tax Adviser. QSBS Gets a Makeover: What Tax Pros Need to Know About Sec. 1202’s New Look
2
Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock
3
Office of the Law Revision Counsel. 26 US Code 1202 – Partial Exclusion for Gain From Certain Small Business Stock
4
eCFR. 26 CFR 1.1202-2 – Qualified Small Business Stock
5
Office of the Law Revision Counsel. 26 USC 1045 – Rollover of Gain From Qualified Small Business Stock to Another Qualified Small Business Stock
6
Internal Revenue Service. Instructions for Form 8949 – Sales and Other Dispositions of Capital Assets