What Is QSBS: Qualification, Holding Period, and Gain Exclusion

Qualified small business stock, often called QSBS, is stock in a domestic C corporation that meets the requirements of Internal Revenue Code Section 1202 and lets a noncorporate holder exclude a large share of the gain when the stock is eventually sold. For shares acquired after July 4, 2025, you can exclude up to $15 million of gain per company (or ten times your basis, whichever is greater), and partial exclusions become available at three and four years of holding. Older shares stay under the prior framework: a $10 million cap and a flat five-year hold for a full exclusion.

Which Companies Qualify

Only domestic C corporations can issue QSBS. S corporations, partnerships, and LLCs taxed as partnerships do not.

The company also has to pass a size test. Its total assets (cash plus the adjusted tax basis of everything else it owns) cannot exceed a dollar ceiling both immediately before and immediately after your stock is issued. For stock issued on or before July 4, 2025, the ceiling is $50 million. For stock issued after that date, it is $75 million, with inflation indexing starting in 2027.¹ If the corporation grows past the ceiling later, your shares generally keep their status. The test is a snapshot taken at issuance, not a running requirement.

Because assets are measured at adjusted tax basis rather than market value, a startup sitting on appreciated intellectual property can still pass even if its valuation is well above the ceiling. Contributed property is the exception: it is measured at fair market value at the time of contribution.¹

The Active Business Test

At least 80% of the corporation’s assets by value must be used in the active conduct of a qualified trade or business during substantially all of your holding period.¹ Congress carved out a long list of industries from the benefit, aiming it at companies building products and technology rather than professional service firms or passive-income businesses. Disqualified fields include:

Health care, law, engineering, architecture, accounting, actuarial science, consulting, and performing arts
Banking, insurance, financing, investing, leasing, and brokerage services
Hotels, motels, and restaurants
Farming, mining, and oil or gas extraction
Any business whose principal asset is the reputation or skill of one or more employees, including athletics

Technology companies, manufacturers, and retailers are the classic QSBS-eligible businesses.¹

Cash Balances After a Fundraise

Startups often hold large cash balances after a funding round, which strains the 80% active-use test. Section 1202 provides a safe harbor: cash and investments count as active-business assets if they are part of the company’s reasonably required working capital or are expected to be spent within two years on research and development or growth.² Once the corporation has existed for at least two years, no more than 50% of its assets can qualify under this safe harbor.

How You Have to Acquire the Stock

You must get the shares at original issuance, directly from the corporation. Stock bought on a secondary market or a stock exchange never qualifies, no matter how small the company is. Your payment has to actually reach the company’s balance sheet.¹

You can pay with cash, with property other than stock, or with services performed for the corporation.² Founders who receive stock for services and employees who receive shares as compensation can both qualify, though the fair market value of stock received for services is generally taxable as ordinary income on receipt. The QSBS benefit then applies to any additional appreciation when you sell.

If you contribute property other than cash, your basis in the shares is treated as no less than the fair market value of the property you contributed. That floor matters because basis drives the ten-times-basis piece of the exclusion cap.²

LLC Conversions

Many startups begin as LLCs and later convert to C corporations before raising venture capital. When that happens, the QSBS holding period generally starts at the conversion date, not the earlier date you joined the LLC. Section 1202 only applies to C corporation stock, and an LLC is not a C corporation.

How Long You Have to Hold

Stock Acquired On or Before July 4, 2025

Older shares need a full five-year hold to qualify for any exclusion. For the vast majority of investors, whose shares were acquired after September 27, 2010, the practical rule is straightforward: hold for five years, exclude 100%.¹ Shares acquired earlier than that fall under prior tiers with smaller exclusion percentages.

Stock Acquired After July 4, 2025

Newer shares get a tiered schedule. You exclude 50% of the gain after three years, 75% after four years, and 100% after five years. An investor who sells at year four now excludes 75% of the gain where the old rules gave nothing.¹

Gifts and Inheritance

If QSBS is transferred by gift or through inheritance, the recipient steps into the original holder’s holding period. Heirs and gift recipients get credit for the time the prior owner held the shares.¹

How Much Gain You Can Exclude

The exclusion is capped per company. The maximum excludable gain from each issuer is the greater of a dollar cap or ten times your adjusted basis in that company’s stock:

Stock acquired on or before July 4, 2025: $10 million lifetime per issuer.
Stock acquired after July 4, 2025: $15 million lifetime per issuer, adjusted for inflation starting in 2027.

The cap is cumulative. It is reduced by any QSBS gain you already excluded from the same company in prior years, and any gain above the cap is taxed at regular capital gains rates.²

The ten-times-basis alternative can dwarf the dollar cap when someone put a lot of money in. A later-stage investor who paid $5 million for shares has a ten-times-basis ceiling of $50 million, which can exceed the dollar cap and become the operative limit. A founder who paid $100,000 for stock has a ten-times-basis ceiling of $1 million, and the dollar cap does the work instead.

The cap applies per taxpayer and per issuer. Every investor in the same company has their own exclusion. Married couples filing separately get half the dollar cap each: $5 million per spouse under the old rules, $7.5 million under the new ones.²

If You Need to Sell Early

Section 1045 offers a way out when the holding period isn’t complete. If you have held the original QSBS for more than six months, you can defer the gain by rolling the proceeds into replacement QSBS within 60 days of the sale.³ The replacement stock itself has to meet every QSBS requirement; buying shares in just any small company will not do.

Only noncorporate taxpayers (individuals, trusts, and estates) can use the rollover. C corporations cannot.⁴ The 60-day window is strict, so replacement stock has to be identified and acquired inside it.

Redemptions Can Kill the Qualification

A share buyback by the company can strip your QSBS status even if everything else is in order. If the corporation repurchases more than a minimal amount of stock from you or a related person during the four-year window starting two years before your stock was issued, the shares are disqualified. “More than minimal” means more than $10,000 in total payments and more than 2% of the stock held by you and related persons.⁵ Founders considering partial buybacks or recapitalizations near a funding round should time these carefully.

AMT and Net Investment Income Tax

For stock acquired after September 27, 2010, the excluded QSBS gain is not treated as an Alternative Minimum Tax preference item. That applies to the 100% exclusion under the old rules and to the 50% and 75% exclusions available for stock issued after July 4, 2025.¹ Investors still holding shares acquired in the earlier 1993–2010 windows can pick up AMT because 7% of the excluded gain is treated as a preference item.

The 100% exclusion also removes exposure to the 3.8% Net Investment Income Tax on the excluded portion, because the excluded gain never enters investment income in the first place. Investors on the 50% or 75% tiers still owe regular capital gains tax and potentially the NIIT on the non-excluded portion.

State Taxes May Still Apply

Section 1202 is a federal benefit, and not every state follows it. Most states conform and let the same gain out at the state level. California, Pennsylvania, Alabama, and Mississippi do not recognize the QSBS exclusion and tax the full gain at ordinary state rates. California’s top rate is 13.3%, and the state hosts a large share of the country’s startup activity, so the mismatch there is the one that hits hardest. A resident of a non-conforming state selling $10 million of QSBS can owe nothing federally and still face a large state bill.

Reporting the Sale

Report the sale on Form 8949, Part II, for long-term capital gains. Identify the stock as Section 1202 qualified small business stock in the description column, enter code “Q” in column (f), and enter the excluded gain as a negative number in parentheses in column (g).⁶ Totals flow through to Schedule D on Form 1040.

Keep the paper trail: the original issuance date, the price you paid, the company’s gross assets at issuance, and evidence that the corporation was a C corporation and met the active business test throughout your holding period. If the IRS asks you to substantiate the exclusion, the burden of proof is yours.

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 U.S. Code 1202 – Partial Exclusion for Gain From Certain Small Business Stock
3
Office of the Law Revision Counsel. 26 USC 1045 – Rollover of Gain From Qualified Small Business Stock to Another Qualified Small Business Stock
4
Office of the Law Revision Counsel. 26 U.S. Code 1045 – Rollover of Gain From Qualified Small Business Stock to Another Qualified Small Business Stock
5
eCFR. 26 CFR 1.1202-2 – Qualified Small Business Stock; Effect of Redemptions
6
Internal Revenue Service. 2025 Instructions for Form 8949 – Sales and Other Dispositions of Capital Assets