Section 1202 Gain Exclusion: Limits, Rollovers, and Reporting

The Section 1202 gain exclusion lets non-corporate taxpayers exclude some or all of the gain from selling qualified small business stock (QSBS) in a domestic C corporation, up to a per-company cap of $10 million or $15 million (or 10 times your basis, if greater). The One Big Beautiful Bill Act, signed July 4, 2025, raised that cap to $15 million for newly issued stock, lifted the company’s gross-assets ceiling to $75 million, and introduced a tiered holding period that pays out a partial exclusion starting at three years. Stock acquired on or before July 4, 2025, still follows the old all-or-nothing five-year rule with the $10 million cap. Which regime applies to you depends entirely on the date your shares were issued.

How Much Gain You Can Exclude

Two numbers decide your exclusion: the percentage of gain that qualifies, and the dollar ceiling that caps it.

The Exclusion Percentage

The percentage is pegged to when you acquired the stock, not when you sell it.

Acquired after September 27, 2010, and on or before July 4, 2025: 100% exclusion after holding more than five years.
Acquired after July 4, 2025: 50% at more than three years, 75% at more than four years, 100% at five years or more.
Acquired after February 17, 2009, through September 27, 2010: 75% exclusion.
Acquired on or before February 17, 2009: 50% exclusion.

The tiered schedule for post-July 4, 2025, stock is the real change. Earlier stock still faces a cliff: sell one day before the five-year mark and the whole gain is taxable. Newer stock captures three-quarters of the benefit even if a forced sale lands at year four.

Only the 100% exclusion is fully sheltered from the Alternative Minimum Tax. If you qualify at the 50% or 75% rate, 7% of the excluded gain is treated as an AMT preference item and can increase your tax under the alternative minimum tax calculation.¹

The Per-Issuer Dollar Cap

The exclusion is limited per taxpayer, per issuing company. For each company, you can exclude the greater of:

$10 million for stock acquired on or before July 4, 2025, or $15 million for stock acquired after that date (with inflation adjustments starting in tax years after 2026), reduced by any gain you already excluded from that same company in prior years, or
10 times the aggregate adjusted basis of the QSBS from that company you sold during the year.

You take whichever is larger.¹ The 10x basis alternative matters most for larger check writers. A $5 million investment supports a $50 million cap, well above the flat figure.

Because the cap resets for each company, investments across multiple qualifying businesses each get their own limit. Because it also resets for each taxpayer, spouses who each independently hold QSBS in the same company can each claim their own cap. A married couple filing jointly could exclude up to $30 million from a single company’s post-July 4, 2025, shares, or up to $20 million from older shares. Gain above the cap flows through to Schedule D as taxable capital gain.

Does Your Stock Actually Qualify

The exclusion only works if the shares meet every QSBS requirement, and the tests look both at the company and at how you acquired the stock.

Entity type. The issuer must be a domestic C corporation during substantially all of your holding period. S corporations, partnerships, LLCs taxed as partnerships, and foreign entities never qualify. Tax practitioners generally read “substantially all” as roughly 85% to 95% of the hold.¹

Original issuance. You must acquire the stock directly from the company (or through an underwriter), in exchange for cash, property other than stock, or services. Shares bought on the secondary market do not qualify in your hands, even if they were QSBS for the person who sold them to you. For stock from option exercises, the holding period starts the day after exercise.¹

Gross assets test. The company’s aggregate gross assets (cash plus the adjusted basis of other property) must stay under the ceiling at all times before issuance and immediately after your shares were issued. That ceiling is $50 million for stock issued on or before July 4, 2025, and $75 million for stock issued after that date, with inflation adjustments starting in tax years after 2026. The test runs only at each issuance, so a company that grows past the threshold later does not strip your existing shares, though it loses the ability to issue new qualifying stock.¹

Active business. At least 80% of the company’s assets, by value, must be used in a qualified trade or business throughout your holding period. This is ongoing, not a snapshot. Several industries are excluded even when actively conducted: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, banking, insurance, financing, leasing, investing, and farming, along with any business whose principal asset is the reputation or skill of one or more employees. A company also fails the test for any period in which more than 10% of its asset value sits in real property not used in a qualified business; owning, dealing in, or renting real property does not count as a qualified use.²

Startups holding large cash balances get some room. Reasonably required working capital counts as used in the active business, as do investment assets reasonably expected to fund research or increased working capital within two years. Once the company has existed for two years, no more than 50% of its assets can lean on this safe harbor.²

One boundary worth knowing: only non-corporate taxpayers can claim the exclusion. Individuals, certain trusts, and estates qualify. C corporations do not. If you hold QSBS through a partnership or S corporation, the exclusion flows through to you, but only if you were a partner or shareholder when the entity bought the stock and held your interest continuously through the sale.³ If you hedged your shares with short sales, puts, or similar risk-reducing positions before meeting the holding period, the exclusion is blocked unless you elect to recognize gain on the first day of the offsetting position.²

Redemptions That Can Quietly Disqualify You

Two separate stock-buyback rules can strip QSBS status. The first disqualifies your shares if the company repurchased stock from you or a related person during the four-year window that starts two years before your issuance. The second disqualifies if, during the two-year window starting one year before your issuance, the company bought back more than 5% of its outstanding stock in the aggregate. Both tests have de minimis exceptions requiring more than $10,000 paid and more than 2% of the relevant stock repurchased before disqualification kicks in.⁴¹ These rules trip up companies that are buying out early investors around the time new funding rounds close. Check the two years before and the year after your issuance for any buyback activity.

If You Have to Sell Before Five Years: The Section 1045 Rollover

Selling QSBS before you hit the required holding period does not automatically end the story. Section 1045 lets you defer the gain by reinvesting the proceeds into replacement QSBS. The stock you sell must have been held for more than six months, and you have 60 days from the sale to buy the replacement shares at original issuance from a company that itself meets the QSBS tests.⁵

Your basis in the original stock carries over to the replacement, reduced by the deferred gain. If you paid $200,000, sold for $1 million, and rolled the full $1 million into new QSBS, your basis in the new stock is $200,000. The $800,000 of deferred gain comes back when you eventually sell in a taxable transaction. The old holding period also tacks onto the new stock, so time already served counts toward the five-year (or three-year) requirement on the replacement shares.⁵

The rollover is not automatic. Make the election on a timely filed return for the year of sale and attach a statement with the sale date, the replacement acquisition date, the adjusted basis of the stock sold, and the gain deferred. Miss the election and you lose the deferral.

Reporting the Exclusion on Your Return

You claim the exclusion on Form 8949 and the totals flow to Schedule D. Report the sale as you would any capital asset: description, acquisition date, sale date, proceeds, cost basis. Then two columns matter.

In column (f), enter code Q for a Section 1202 exclusion. In column (g), enter the excludable portion of the gain as a negative number in parentheses. For a 100% exclusion, the negative adjustment equals the full gain and your recognized gain is zero. For a 50% or 75% exclusion, the negative is only that share of the gain.⁶

The negative adjustment cannot exceed the lesser of your actual gain or your per-issuer cap. With $18 million of gain and a $15 million cap, the column (g) adjustment is negative $15 million and the remaining $3 million rolls through as taxable capital gain on Schedule D.

For a Section 1045 rollover, the mechanics are the same except you enter code R in column (f) and the full deferred gain as a negative in column (g), with the election statement attached.⁶

If you hold QSBS through a partnership, the partnership reports your share of eligible gain on Schedule K-1 (Form 1065) in Box 11 with Code O, along with the issuing company’s name, your share of basis and sales price, and the acquisition and sale dates. You then run your own exclusion calculation and make the adjustment on your personal Form 8949. The partnership does not claim the exclusion itself.³

Documentation You Will Need

The IRS puts the burden of proof on you, and this is where many claims collapse. In a Tax Court case where the taxpayer’s QSBS was issued in 2003 but the financial records only covered 2009 through 2011, the court rejected the exclusion because the gross-assets test could not be proven from inception through issuance. A gap in records can be fatal.

Keep documentation covering:

Balance sheets showing the company’s aggregate gross assets stayed below the applicable threshold from formation through immediately after your shares were issued.
Articles of incorporation, tax elections, and returns confirming C corporation status throughout your hold.
Stock purchase agreements, board resolutions, or option exercise records proving original issuance.
Periodic asset breakdowns showing at least 80% of company assets stayed in a qualified business.
Clear dates for issuance (or option exercise) and sale.

If you received shares years after the company formed, ask for a corporate certification of QSBS eligibility at issuance and keep it permanently. Some investor rights agreements include covenants requiring the company to perform periodic QSBS qualification analyses and share the results. That paper trail will matter years later.

State Tax Can Take a Bite the Federal Rules Don’t

A full federal exclusion does not guarantee a tax-free sale. Several states do not conform to Section 1202 at all, meaning the gain is fully taxable at the state level. California is the biggest exposure, with a top marginal rate of 13.3% applying to the full gain. Pennsylvania, Mississippi, and Alabama also reject the federal exclusion. Most other states conform in whole or in part, but conformity rules shift, so confirm your state’s current position before you count on a complete exclusion. The state bill on a large sale can reach seven figures.

Multiplying the Cap Through Gifts and Trusts

Because the cap is per taxpayer and QSBS can be transferred by gift with the holding period and basis carrying over, some holders gift shares to family members or non-grantor trusts before a sale. Each recipient becomes a separate taxpayer with its own cap. A founder with $60 million of unrealized gain could, in principle, gift shares to several non-grantor trusts and family members, each claiming a separate $15 million exclusion.

The IRS watches this closely. Gifts must happen well before any binding commitment to sell. Transfer shares after signing a letter of intent and the IRS can treat the sale as yours under the assignment-of-income doctrine. The receiving trust must be a non-grantor trust; a grantor trust accomplishes nothing because the grantor is still the owner for income tax. Multiple trusts with substantially the same primary beneficiary, created by the same grantor with tax avoidance as a principal purpose, can be collapsed into one taxpayer. Spouses count as a single grantor, so mirror-image trusts for the same child will not survive. This is strategy to run with a tax advisor, not a DIY move.

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
Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065)
4
eCFR. 26 CFR 1.1202-2 – Qualified Small Business Stock; Effect of Redemptions
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 (2025) Sales and Other Dispositions of Capital Assets