What Section 1202 does
Internal Revenue Code Section 1202 lets non-corporate shareholders exclude federal capital gain on the sale of qualified small business stock (QSBS). Congress enacted it to encourage long-term investment in operating businesses. The exclusion is per issuer and per taxpayer, capped at the greater of a dollar limit or 10 times the taxpayer's adjusted basis in the stock.
The requirements
- Entity type. The issuer must be a domestic C-corporation when the stock is issued and during substantially all of the holding period.
- Original issuance. You must acquire the shares directly from the corporation for money, property, or services, not from another shareholder.
- Gross assets. The corporation's aggregate gross assets cannot exceed the limit ($50 million for stock issued on or before July 4, 2025; $75 million after) at any time before and immediately after issuance.
- Active business. At least 80% of assets must be used in a qualified trade or business. Professional services, financial services, hospitality, farming, and extraction businesses are excluded.
- Holding period. Five years for stock issued on or before July 4, 2025. For later issuances, 50% exclusion at three years, 75% at four, and 100% at five.
Old rules versus new rules
| Stock issued on or before July 4, 2025 | Stock issued after July 4, 2025 | |
|---|---|---|
| Per-issuer cap | $10 million or 10× basis | $15 million (indexed after 2026) or 10× basis |
| Gross-asset test | $50 million | $75 million (indexed after 2026) |
| Holding period | 5 years for 100% | 3 years 50%, 4 years 75%, 5 years 100% |
Why timing decides everything
The holding period begins on the day the C-corporation issues your stock, not the day you founded an LLC or elected S status. Once a buyer submits a letter of intent, your structure is effectively locked; there is no election or retroactive filing that starts the clock mid-transaction. If you might sell in 2031, the restructuring conversation belongs on this year's calendar.
The trade-offs
Converting to a C-corporation means corporate-level tax on operating profits and a second layer of tax on dividends, which can cost more than the exclusion saves for a business that distributes most of its earnings and is unlikely to sell. The analysis has to compare the expected exit value, the years to exit, and the operating profile of the business. That is the work we do with your CPA.
What happens after the exit
A large excluded gain changes the rest of the plan: where the proceeds are invested, how much gain the new portfolio should realize each year, and whether gifting or trust strategies (including stacking the exclusion across trusts, which requires careful counsel) belong in the picture. See our business owner page and the Personal Index Portfolios we use for post-sale portfolios.
For the full walk-through, read The $15 million exit mistake or request the CPA Survival Guide.