Change May Be Good
The enactment earlier this year of the One Big Beautiful Bill Act (the “Act”)[i] generated a fair amount of excitement in the business community.[ii]
If one had to identify a single provision of the Act in which the owners and prospective owners of start-up and emerging businesses have expressed particular interest, the amendment of the Code’s gain-exclusion rule for the sale or exchange of stock of a qualified small business[iii] may be the one most frequently mentioned.
Unfortunately, many of these business owners and potential investors – at least based upon my conversations with such folks – do not fully understand the interaction of the provision’s revised “holding” requirements with its “acquisition date” rules, and the consequences resulting therefrom.
Before addressing this not unreasonable confusion, let’s review the basic gain-exclusion rules of Section 1202 of the Code and the Act’s changes thereto.
The Sale of Stock
In general, the gain from the sale or exchange of shares of stock in a corporation that have been held for more than one year is treated as long-term capital gain (“LTCG”).[iv]
The net capital gain of a non-corporate taxpayer (“Shareholder”) for a taxable year – i.e., their net LTCG less their net short-term capital loss for the taxable year – has, for many years, been subject to a reduced federal income tax rate, as compared to the rate applicable to ordinary income.[v]
QSBS
In 1993, Congress determined that it could encourage the flow of investment capital to new ventures and small businesses – many of which, Congress believed, had difficulty attracting equity financing – if the Code provided additional “relief” for non-corporate investors, such as Shareholder, who risked their funds in such businesses.[vi]
Under the relief or, more appropriately, the incentive provision enacted by Congress,[vii] a non-corporate taxpayer was generally permitted to exclude up to 50-percent of the gain from their sale or exchange of a corporation’s (“Corp”) “qualified small business stock” (“QSBS”).[viii]
Subsequent legislation increased the portion of the gain excludible from gross income from 50-percent to 75-percent,[ix] and then to 100 percent, of the gain from their sale or exchange of the QSBS.[x]
In any case, the amount of gain that may actually be excluded is statutorily capped at an amount that may be less than the amount of gain determined under the two immediately preceding sentences.[xi]
Pre-Issuance Gain?
Significantly, for purposes of this post, the amount of gain realized by Shareholder from their sale of QSBS that may be considered for exclusion from income under the above rules is limited to the gain that accrued after the Shareholder’s acquisition of the QSBS from the issuing corporation (Corp).
Thus, the sale gain excludible from income does not include the gain that was inherent in[xii] any appreciated property exchanged by Shareholder with Corp for the issuance of the QSBS – such built-in gain represents the return on an earlier investment made by Shareholder and, so, should not benefit from the gain-exclusion rule; only gain that accrues in the QSBS after such appreciated property is transferred to the corporation may be considered for exclusion.[xiii]
Makes sense in light of the policy underlying the gain-exclusion rule,[xiv] right?
The Code implements this limitation by providing, for purposes of the gain-exclusion rule,[xv] that the basis of the QSBS in the hands of the taxpayer must be at least equal to the fair market value of the appreciated property at the time it is exchanged for the QSBS with the corporation.[xvi]
Qualified C Corporation
In order for a selling shareholder to be eligible for the gain-exclusion benefit, the stock being sold, and the corporation from which it was issued, must satisfy several criteria.
For example, (a) the stock must have been acquired directly from the issuing corporation;[xvii] (b) the stock must have been acquired in exchange for money or other property (not including stock), or as compensation for services provided to the corporation;[xviii] (c) the issuing corporation must have been a C corporation at the time of issuance; (d) the corporation must have been a C corporation during substantially all of the taxpayer’s holding period[xix] for such stock;[xx] (e) at the time of issuance, the corporation must have been engaged in an active business;[xxi] (f) during substantially all of the taxpayer’s holding period for the stock, the corporation must have met the active business requirement;[xxii] (g) at least 80-percent (by value) of the corporation’s assets (including intangible assets) must have been used by the corporation in the active conduct of one or more qualified trades or businesses; and (h) the corporation’s “aggregate gross assets” must not have exceeded $75 million[xxiii] immediately after the exchange and at no time prior to the exchange.[xxiv]
Exclusion of Gain
If the various criteria are satisfied, and if certain missteps are avoided,[xxv] a non-corporate taxpayer (Shareholder) who acquired QSBS from the issuing corporation (Corp) after July 4, 2025, and who holds such QSBS for at least 3 years (more than 5 years in the case of stock acquired on or before July 4, 2025) may exclude from gross income a portion of the gain from the subsequent sale of such stock (“eligible gain”).[xxvi]
Per-Issuer Limitation
As stated above, the Code imposes a cap upon the amount of gain from the sale of Corp’s QSBS that Shareholder may exclude from gross income for the year of such sale.[xxvii]
If Shareholder has gain for the taxable year from one or more sales of Corp’s QSBS that Shareholder held for at least 3 years – more than 5 years in the case of QSBS acquired on or before July 4, 2025 – the aggregate amount of such gain[xxviii] from such sales of Corp’s QSBS that may be taken into account by Shareholder for purposes of determining Shareholder’s excludible gain for the year of the sale (the “per-issuer limitation”) is capped at the greater of:
I.
a. if such stock was acquired by Shareholder on or before July 4, 2025:
- i.$10 million ($5 million for a married individual filing separately), reduced by the
- ii. aggregate amount of eligible gain that was taken into account by Shareholder under the gain-exclusion rule for prior taxable years and that was attributable to the sale of QSBS acquired by Shareholder before, on, or after July 4, 2025; and
b. if such stock was acquired by Shareholder after July 4, 2025:
- i. $15 million ($7.5 million for a married individual filing separately),[xxix] reduced by the sum of:
1. the aggregate amount of eligible gain taken into account by Shareholder for prior taxable years and attributable to the sale of QSBS issued by Corp, and acquired by Shareholder before, on, or after July 4, 2025,
plus
2. the aggregate amount of eligible gain taken into account by Shareholder for the taxable year and attributable to the sale of stock issued by Corp, and acquired by the Shareholder, on or before July 4, 2025;[xxx]
Or
II. 10 times the aggregate adjusted bases of QSBS issued by Corp[xxxi] and sold by Shareholder during the taxable year (determined without regard to any addition to basis after the date on which such stock was originally issued to Shareholder).
Holding Period
For purposes of determining the cap described above, one must establish the date on which Shareholder acquired the QSBS in question and the period for which Shareholder held such QSBS.
In general, a taxpayer’s holding period for a purchased asset – one acquired in a taxable sale or exchange – is computed by excluding the date on which the asset is acquired; i.e., the holding period begins on the date immediately after the acquisition date.[xxxii]
A different holding period rule applies where stock is acquired in exchange for appreciated property in the context of a tax-deferred exchange.
IRC Sec. 351 – the General Tacking Rule
For example, if appreciated property is contributed to a corporation by one or more persons solely in exchange for stock in such corporation, and such person(s) are in control of the corporation immediately after such exchange, the exchange will be treated as a tax-deferred transaction.[xxxiii]
The contributing (or exchanging) shareholder’s basis for the stock received from the corporation in the exchange would generally be the same as that of the appreciated property exchanged with the corporation.[xxxiv]
In determining the period for which the contributing shareholder has held the stock received in the exchange, there is included the period for which the shareholder held the appreciated property exchanged.[xxxv]
IRC Sec. 1202 – Not the General Rule
However, for purposes of the gain-exclusion rule, if Shareholder contributed appreciated property[xxxvi] to Corp in exchange for QSBS in the same tax-deferred transaction,[xxxvii] Shareholder’s basis for the QSBS received would in no event be less than the fair market value of the property exchanged with Corp.[xxxviii]
Recall the policy reason for this “basis step-up”: to ensure that only gain that accrues after Shareholder has actually acquired the QSBS may be excluded from income under the exclusion rule.
Moreover, Shareholder’s tacked holding period for the contributed property would be disregarded for purposes of applying the post-acquisition/pre-sale holding requirement with respect to the QSBS received in the exchange;[xxxix] instead, the Corp stock would be treated as having been acquired by Shareholder on the date of the exchange.[xl]
Thus, for purposes of applying the pre-OBBBA gain-exclusion rule’s 5-year “holding” requirement, as well as the post-OBBBA 3-year, 4-year, and 5-year “holding” requirements, Shareholder will begin counting with the date on which the QSBS in question was actually acquired by Shareholder,[xli] as distinguished from the date on which Shareholder’s holding period is deemed to have begun. The significance of this last point is considered immediately below.
Acquisition Date Distinguished
Let’s assume the stock issued to Shareholder by Corp is QSBS. Let’s also assume Shareholder later sells the stock.
In general, Shareholder’s gross income won’t include 50 percent of any gain from the sale of the QSBS if the stock was acquired on or before July 4, 2025, and Shareholder held such stock for more than 5 years.
As mentioned earlier, however, there were legislative changes to the 50 percent exclusion rule even before OBBBA.[xlii] How is Shareholder to determine which of these alternative exclusions will apply to the gain from the sale of the QSBS issued to Shareholder?
Policy . . . Again
Before addressing this question, let’s revisit the policy underlying the gain-exclusion rule: to encourage new investment in a qualified small business by excluding from a shareholder’s income some portion (maybe all) of the gain from the sale of the QSBS issued to the shareholder.
An investment of money represents an investment of new funds in a qualified small business. There is no built-in gain in respect of an earlier investment with which to be concerned.
The value of an investment of appreciated property in exchange for QSBS, however, represents the gain that accrued with respect to an earlier investment in other property by Shareholder.
But wait, you might ask, don’t the gain exclusion rules already require that the QSBS received by Shareholder receive a fair market value basis, thereby eliminating the possibility of excluding any part of the built-in gain?
Although that’s correct, Shareholder still has to determine which of the gain-exclusion rules will apply to the later sale of the QSBS.
For example, assume a taxpayer made an investment in a property that has since appreciated. Some time after July 4, 2025, the taxpayer transfers the property to a corporation in a tax-deferred exchange in exchange for QSBS. Should the taxpayer enjoy the benefit of OBBBA’s more generous gain exclusion rules because the QSBS was actually acquired after July 4, 2025? Or should the QSBS be treated as the continuation of the taxpayer’s earlier, still unliquidated investment?
Which brings us to the discussion below.
After February 17, 2009, On or Before September 27, 2010[xliii]
If Shareholder acquired the QSBS after February 17, 2009 and on or before September 27, 2010, Shareholder’s gross income will not include 75 percent of any gain from the sale of such QSBS, provided Shareholder held the stock for more than 5 years.[xliv]
The acquisition date for purposes of the foregoing rule – i.e., for purposes of determining whether the QSBS was acquired by Shareholder after February 17, 2009 and on or before September 27, 2010 – is the first day on which such stock was held by Shareholder, determined after application of the Code’s regular holding period tacking rules – not the date on which the QSBS was actually issued to Shareholder.[xlv] In other words, Shareholder has to look to the time the investment in the other property was made.
Specifically, if Shareholder contributed appreciated property to Corp in exchange for QSBS,[xlvi] and Shareholder’s basis for such stock was the same as the basis of the contributed property under the generally applicable basis rules,[xlvii] then Shareholder would be treated as having acquired the QSBS at the beginning of Shareholder’s tacked holding period for the contributed property – not the date on which the QSBS was actually issued to Shareholder.[xlviii]
Thus, if Shareholder’s holding period for the appreciated property began on or prior to February 17, 2009, the 50 percent (and not the 75 percent) gain exclusion rule would apply with respect to the gain from the sale of Shareholder’s QSBS notwithstanding the stock was actually acquired after February 17, 2009 and on or before September 27, 2010.
However, for purposes of applying the 5-year holding requirement described above, Shareholder would start counting with the date on which the QSBS was actually acquired.
After September 27, 2010, On or Before July 4, 2025[xlix]
If Shareholder acquired the QSBS from Corp after September 27, 2010, and on or before July 4, 2025, Shareholder’s gross income would not include 100 percent of any gain from the sale, provided such QSBS was held by Shareholder for more than 5 years.[l]
Again, if Shareholder contributed appreciated property to Corp in exchange for the QSBS, and Shareholder’s basis for such stock was the same as the basis of the contributed property under the usual basis rules, then Shareholder would be treated as having acquired the QSBS at the beginning of Shareholder’s holding period for the contributed property.[li]
Thus, if Shareholder’s holding period for the appreciated property began some time after February 17, 2009 and on or before September 27, 2010, the 75 percent (not the 100 percent) gain exclusion rule would apply to the gain from the sale of the QSBS notwithstanding the stock was actually acquired after September 27, 2010 and on or before July 4, 2025.
Brief Recap
In each of the foregoing “on or before July 4, 2025 acquisition” scenarios, if the QSBS is sold before Shareholder has actually held the stock for more than 5 years, Shareholder will not enjoy any gain-exclusion benefit.
Before addressing the tax treatment of QSBS that was acquired after July 4, 2025 and which, therefore, may qualify for the more forgiving holding and partial gain-exclusion rules enacted by OBBBA, let’s consider the effect of the acquisition date rules described above.
If a taxpayer contributed money to a corporation in exchange for QSBS, the taxpayer’s “acquisition date” and the date from which the applicable holding rule is applied (i.e., the date on which the taxpayer actually received the QSBS) are one and the same.
However, if the taxpayer contributed appreciated property to the corporation in a tax-deferred exchange for QSBS, the taxpayer is treated, under the tacking rule, as having acquired the stock on the date the taxpayer acquired the appreciated property. This is the date that is used to determine in which of the above “brackets” of time the taxpayer acquired the QSBS and, therefore, the percentage of gain the taxpayer may exclude from the sale of such stock under the gain exclusion rule.[lii]
Now let’s consider a post-July 4, 2025 acquisition of QSBS.
After July 4, 2025
If the QSBS sold by Shareholder was acquired from Corp in exchange for money after July 4, 2025, then Shareholder would exclude from gross income: 50 percent of the gain if the QSBS was held for at least 3 years after acquiring the stock; 75 percent of the gain if the QSBS was held at least 4 years, and 100 percent of the gain if the QSBS was held at least 5 years.[liii]
In the case of any QSBS which was issued by Corp to Shareholder in a tax-deferred exchange for appreciated property after July 4, 2025, Shareholder’s acquisition date for purposes of determining which of the gain exclusion rules apply (i.e., in which of the time “brackets” described above the stock is deemed to have been acquired) is the first day on which Shareholder’s holding period for the QSBS is deemed to have begun after application of the holding period tacking rules.[liv]
Thus, if Shareholder’s holding period for the appreciated property began some time after September 27, 2010 and on or before July 4, 2025, Shareholder would not be entitled to use OBBBA’s more relaxed gain-exclusion rules; instead, Shareholder will have to satisfy the 5-year holding requirement in order to exclude any portion of the gain from the sale of QSBS, notwithstanding the stock was actually acquired after July 4, 2025.
What’s the Point?
The policies underlying the application of the gain exclusion rules to QSBS acquired in exchange for appreciated property are well-founded.
As indicated at the start of today’s post, however, many taxpayers, if not most, are unaware of the practical results of these policies on the tax treatment of QSBS that is issued to a shareholder in exchange for the latter’s contribution of appreciated property that was acquired by the contributor before OBBBA.
Fortunately, OBBBA’s more generous gain-exclusion rules are only 4 months old and we are still in 2025.
That said, there are probably many partners who, in order to take advantage of the revised rules, are considering the incorporation of their partnership, but who do not appreciate that the application of the above-described “acquisition date” rules may land them in the less favorable pre-OBBBA regime.
As always, the expectations of an investment have to be managed and its after-tax economics must be understood.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.
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[i] On July 4, 2025. P.L. 117-169. There are times I’ve wished Congress had a staff of brand consultants to help with naming newly enacted legislation. “One Big Beautiful Bill Act”? It conveys nothing of its substance, and the alliteration drives me nuts.
[ii] This is understandable, considering some of its changes to the Code; for example, the deduction for bonus depreciation was made permanent; the deduction for domestic research and experimental expenditures was restored; the limitation on the deduction for business interest was relaxed; and the maximum amount that may be expensed under section 179 was increased as was the phaseout threshold amount.
[iii] IRC Sec. 1202.
[iv] IRC Sec. 1222. This is the case for both C corporation and S corporation stock. Compare the gain from the sale of a partnership interest: it is treated as gain from the sale of a capital asset, except to the extent the consideration received by the selling partner is attributable to the partner’s share of the partnership’s “hot assets.” IRC Sec. 741 and Sec. 751.
[v] IRC Sec. 1(h). Indeed, from 1993 into 1998, the capital gain rate was capped at 28-percent; from 1998 into 2003, it was capped at 20-percent; from 2003 through 2012, it was capped at 15-percent; and from 2013 through today, it has been capped at 20-percent. The ordinary income and capital gain of a C corporation are taxed at a flat 21% rate.
Beginning with 2013, an individual’s capital gain may also be subject to the 3.8-percent surtax on net investment income. IRC Sec. 1411.
[vi] P.L. 103-66; the Omnibus Budget Reconciliation Act (“OBRA”) of 1993.
[vii] IRC Sec. 1202.
[viii] The remaining LTCG would continue to be taxed at a reduced rate (as compared to ordinary income).
[ix] P.L. 111-5; the American Recovery and Reinvestment Act.
[x] P.L. 111-240; the Small Business Jobs Act of 2010.
[xi] “Less than” does not mean “insignificant,” at least not for most of us.
[xii] Built into.
[xiii] For example, if the shareholder in question acquired the QSBS from the issuing corporation in exchange for a contribution of appreciated property (other than stock), as part of an exchange described in IRC Sec. 351, the appreciation built into the stock issued by the corporation (reflecting and preserving/deferring the gain inherited or attributed from the contributed property) is not excludible under IRC Sec. 1202. See IRC Sec. 1202(i)(1)(B), Sec. 351, Sec. 358(a)(1). In addition, the shareholder’s holding period for the stock received in the Sec. 351 exchange – for purposes of determining the nature of the gain from the subsequent sale of such stock as long or short term – includes the shareholder’s holding period for the appreciated property in exchange for which the stock was received. Sec. 1223(1).
[xiv] To attract investment to a start-up business, and to hold such investment – i.e., to put it at risk – for a significant period of time. Think on it, the Code taxes at a favorable rate an individual taxpayer’s gain from the sale of certain property that such taxpayer held for more than one year (LTCG). IRC Sec. 1(h) and Sec. 1222.
[xv] Not for purposes of calculating the total gain from the sale pursuant to IRC Sec. 1001 and Sec. 1011 (adjusted basis).
[xvi] IRC Sec. 1202(i)(1)(B). “For purposes of this section … In the case where the taxpayer transfers property (other than money or stock) to a corporation in exchange for stock in such corporation … the basis of such stock in the hands of the taxpayer shall in no event be less than the fair market value of the property exchanged.”
For example, Shareholder has held Prop for several years. When Shareholder contributes Prop to Corp in a tax-deferred exchange for shares of Corp stock that satisfy the criteria for QSBS, Prop A has a FMV of $1 million, and an adjusted basis of $100,000. If Shareholder sells the QSBS before such stock has appreciated in value, Shareholder will realize, and be taxed on, $900,000 of LTCG. However, for purposes of the gain exclusion rule, Shareholder’s stock basis is equal to $1 million (the FMV of Prop when it was contributed to Corp); thus, Shareholder did not realize any excludible gain.
Alternatively, if Shareholder had sold the QSBS for $1.2 million, Shareholder would realize $1.1 million of LTCG ($1.2 million over $100,000 of stock basis), of which $200,000 ($1.2 million minus $1 million QSBS basis) qualified for the gain-exclusion rule of IRC Sec. 1202.
[xvii] With limited exceptions. In the case of certain transfers, including, for example, a transfer by gift or at death, the transferee is treated as having acquired the stock in the same manner as the transferor, and as having held the stock during any continuous period immediately preceding the transfer during which it was held by the transferor. Likewise in the case of a distribution of QSBS from a partnership to a partner, provided certain conditions are met. IRC Sec. 1202(h)(2)(C).
[xviii] IRC Sec. 1202(c).
[xix] More on the “holding period” question shortly.
[xx] The decision by a start-up business and its owners to operate through a C corporation, so as to position themselves to take advantage of the exclusion of gain from the sale of stock in a qualified small business corporation, was no small matter when the relief provision was enacted. In 1993, the maximum federal corporate income tax rate was set at 34-percent; dividends paid to individual shareholders from a C corporation were subject to the same 39.6-percent federal income tax rate applicable to ordinary income. From 1994 through 2017, the corporate tax rate was capped at 35-percent; until 2003, dividends paid to individuals continued to be taxed at the higher rates applicable to ordinary income, though, after 2002, the federal tax rate on such dividends was reduced and tied to the federal LTCG rate. Unfortunately, beginning with 2013, the dividends paid by a C corporation to a higher-income individual shareholder became subject to the 3.8-percent surtax on net investment income, regardless of the individual’s level of participation in the corporation’s business. IRC Sec. 1411.
It is likely that the combination of (i) a high federal corporate tax rate, (ii) the taxation (initially at ordinary income rates) of any dividends distributed by the corporation to its shareholders – the so-called “double taxation” of C corporation profits – and (iii) the many threshold requirements that had to be satisfied (see below), conspired to prevent Sec. 1202 from fulfilling its mission.
Thus, the capital gain relief provision was relegated to the shadows, where it remained dormant until . . . it was rediscovered by Smeagol, who lost it to a Hobbit, who then became a star of literature and cinema.
Effective for taxable years of C corporations beginning after December 31, 2017, the Tax Cuts and Jobs Act reduced the federal corporate tax rate from a maximum of 35-percent to a flat 21-percent. P.L. 115-97.
Since then, Sec. 1202 has been like the “new kid in town,” as the Eagles sang: “Great expectations, everybody’s watching you. . . They will never forget you ’til somebody new comes along.”
Of course, there are many other factors that may cause the owners of a closely held business to decide against the use of a C corporation.
[xxi] A “qualified trade or business” is any trade or business, other than those involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business where the principal asset of the trade or business is the reputation or skill of one or more of its employees. IRC Sec. 1202(e)(6).
The term also excludes any banking, insurance, leasing, financing, investing, or similar business, any farming business, any business involving the production or extraction of products of a character for which depletion is allowable, or any business of operating a hotel, motel, restaurant or similar business. IRC Sec. 1202(e)(3).
[xxii] IRC Sec. 1202(c)(2)(A).
[xxiii] $50 million for stock issued on or before July 4, 2025.
For purposes of this requirement, the term “aggregate gross assets” means the amount of cash and the aggregate adjusted bases of other property held by the corporation. However, the adjusted basis of any property contributed to the corporation is determined as if the basis of the property contributed to the corporation (immediately after such contribution) were equal to its fair market value as of the time of such contribution. This amount is subject to adjustment for inflation starting in 2027.
It should be noted that, if a corporation satisfies the gross assets test as of the date of issuance, but subsequently exceeds the $75 million threshold, stock that otherwise constitutes qualified small business stock would not lose that characterization solely as a result of that subsequent event, but the corporation can never again issue stock that would qualify for the exclusion.
Both the issuing corporation and the contributing taxpayer will have to be very careful to determine the fair market value of any in-kind contribution of property to the corporation – its contribution may cause the corporation to exceed the threshold and thereby disqualify the contributing taxpayer and any future contributors from taking advantage of the gain-exclusion rule.
[xxiv] It is assumed the corporation in question was formed after the enactment of the OBRA of 1993.
[xxv] For example, more than 10% of the value of the corporation’s assets (in excess of liabilities) consist of stock or securities in other corporations (other than subsidiaries of the corporation), excluding working capital; more than 10% of the total value of its assets consists of real property which is not used in the active conduct of a qualified trade or business; or the corporation engaged in certain redemptions of its stock within a specified period beginning before and ending after the issuance of its stock (to prevent evasion of the requirement that the stock be newly issued). IRC Sec. 1202(c)(3).
[xxvi] IRC Sec. 1202(a). In addition, the excluded gain will not be subject to the surtax on net investment income; nor will it be added back as a preference item for purposes of determining the taxpayer’s alternative minimum taxable income.
[xxvii] A similar cap is determined with respect to the gain from Shareholder’s sale of QSBS during the year that was issued by different C corporation.
[xxviii] IRC Sec. 1202(b).
[xxix] This amount will be adjusted for inflation in taxable years beginning after 2026. IRC Sec. 1202(b).
It should be noted that once a selling shareholder has passed this inflation-adjusted cap, the shareholder may not enjoy the benefit of any inflation adjustments to the cap for a subsequent taxable year. IRC Sec. 1202(b).
[xxx] IRC Sec. 1202(b). Note that the first of these limits operates on a cumulative basis, beginning with the taxpayer’s acquisition of the stock and ending with the taxable year in question; the second operates on an annual basis, and depends upon how much stock was disposed of during such taxable year.
For purposes of the second limit, the adjusted basis of any stock is determined without regard to any addition to basis after the date on which such stock was originally issued. IRC Sec. 1202(b)(1).
[xxxi] Such basis being equal to the amount of money and the fair market value of other property contributed to the corporation in exchange for QSBS. IRC Sec. 1202(i).
[xxxii] Rev. Rul. 99-5, citing Rev. Rul. 66-7.
[xxxiii] IRC Sec. 351(a).
[xxxiv] To preserve in the hands of the shareholder the pre-exchange gain of the appreciated property contributed to the corporation.. IRC Sec. 358. Similarly, the basis of the property acquired by the corporation in the exchange is the same as it was in the hands of the contributing shareholder. IRC Sec. 362.
[xxxv] IRC Sec. 1223(1). This holding period tacking rule applies if the stock has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in the shareholder’s hands as the appreciated property exchanged, and such property was a capital asset (as defined in IRC Sec. 1221) or property described in IRC Sec. 1231.
[xxxvi] A contribution in-kind (not cash), other than stock.
[xxxvii] Say, IRC Sec. 351.
[xxxviii] IRC Sec. 1202(i)(1)(B).
[xxxix] Meaning the 3-year, 4-year, and 5-year holding period tests.
[xl] IRC 1202(i)(1)(A). You’ll note that IRC Sec. 1202(i) begins with the language, “For purposes of this section,” meaning Sec. 1202 as a whole, and not for any particular subsection – specifically, those that include references to IRC Sec. 1223, which are described below.
[xli] The date of the exchange.
[xlii] The portion of the gain excludible from gross income was increased from 50 percent to 75 percent, and then to 100 percent, of the gain from the sale of the QSBS.
[xliii] During the period beginning with the effective date of the American Recovery and Reinvestment Act and ending before the effective date of Small Business Jobs Act of 2010.
[xliv] IRC Sec. 1202(a)(3)(A).
[xlv] IRC Sec. 1223; IRC Sec. 1202(a)(3), last sentence:
“In the case of any stock which would be described in the preceding sentence (but for this sentence), the acquisition date for purposes of this subsection shall be the first day on which such stock was held by the taxpayer determined after the application of section 1223.”
(Emph. added.)
[xlvi] Say, as part of an exchange described in IRC Sec. 351.
[xlvii] IRC Sec. 358(a)(1). An exchange is described in IRC Sec. 351 if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in “control” of the corporation. See IRC 368(c) for the meaning of “control.”
[xlviii] IRC Sec. 1223(1). Of course, if Shareholder acquired the QSBS in exchange for a contribution of money to Corp, the acquisition date was the day after the acquisition date of the exchange.
[xlix] During the period beginning with the effective date of the Small Business Jobs Act of 2010 and ending before the effective date of OBBBA.
[l] IRC Sec. 1202(a)(4)(A).
[li] IRC Sec. 1202(a)(4), last sentence:
“In the case of any stock which would be described in the preceding sentence (but for this sentence), the acquisition date for purposes of this subsection shall be the first day on which such stock was held by the taxpayer determined after the application of section 1223.”
(Emph. added.)
[lii] For example, assume the following: Shareholder contributed appreciated property to Corp in a tax-deferred exchange for QSBS after September 27, 2010, and on or before July 4, 2025; Shareholder’s holding period (under the tacking rules) begins February 15, 2009; this is also Shareholder’s “acquisition date” for purposes of determining which of the “time brackets” applies; Shareholder sells the QSBS after 5 years. Based on the foregoing, Shareholder may exclude 50 percent of the gain from the sale, notwithstanding the QSBS was actually issued to Shareholder after September 27, 2010, and on or before July 4, 2025 (i.e., the period for which the 100 percent exclusion rule would otherwise have been applicable).
[liii] IRC Sec. 1202(a)(5).
[liv] IRC Sec. 1202(a)(6)(B). The statutory language here is confusing. Hopefully, it will be cleaned up soon. The most rational reading is the one set forth above.