Section 1202 has been around since 1993. For most of that time it was a niche provision, useful in the right circumstances but constrained by a rigid five-year holding period and dollar thresholds that hadn’t kept pace with inflation. The One, Big, Beautiful Bill Act (OBBBA), signed into law July 4, 2025, changed that.
Three specific amendments to IRC Section 1202 took effect for stock issued after July 4, 2025: a tiered holding period with graduated exclusions, a higher per-taxpayer gain exclusion cap, and an increased gross asset threshold. The core eligibility requirements, however, remain intact and unforgiving.
What Section 1202 Covers
Section 1202 allows noncorporate taxpayers to exclude capital gains from the sale or exchange of qualified small business stock (QSBS). Prior to the OBBBA, a taxpayer who acquired QSBS after September 27, 2010 and held it for more than five years could exclude 100% of the gain, subject to a cap of the greater of $10 million or 10 times the aggregate adjusted basis of the stock sold.
The OBBBA left the overall structure intact. What changed are three specific parameters: how long you have to hold the stock, how much gain can be excluded, and how large the issuing company can be.
Core Eligibility Requirements
These five requirements apply to all QSBS claims, both pre- and post-OBBBA. Each must be satisfied throughout the holding period.
1. C Corporation Issuer
The issuing entity must be a domestic C corporation at the time the stock is issued. Stock issued by S corporations, partnerships, or LLCs taxed as partnerships does not qualify. Only equity issued after a valid conversion to C corporation status is eligible. Stock held in an entity previously taxed as an S corporation is generally prohibited from receiving QSBS treatment, subject to complex exceptions related Section 368(a)(1)(f) reorganizations.
2. Original Issuance
The taxpayer must acquire the stock at original issuance, in exchange for money, property (except stock in another corporation), or services. QSBS cannot be acquired by exchange of one company stock for newly issued QSBS unless the exchange is executed as part of a plan of reorganization under Section 368. Further, stock purchased on a secondary market does not qualify.
3. Gross Asset Threshold
The corporation’s aggregate gross assets, both before and immediately after the stock issuance, cannot exceed the applicable threshold. For stock issued on or before July 4, 2025, that threshold is $50 million. For stock issued after July 4, 2025, the OBBBA raised it to $75 million, with annual inflation adjustments beginning in 2027.
Aggregate gross assets means cash plus the adjusted basis of other property held by the corporation. Fair market value is not used, except for contributed property, where fair market value at the time of contribution applies. In a parent-subsidiary controlled group, all members are treated as one corporation for purposes of this test.
4. Active Business Requirement
At least 80% of the corporation’s assets, by value, must be used in the active conduct of one or more qualified trades or businesses. Section 1202(e)(3) excludes certain service industries from the definition of a qualified trade or business, including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Also excluded are businesses whose principal asset is the reputation or skill of one or more employees, and businesses in banking, insurance, financing, leasing, investing, farming, hospitality, and certain other industries. Functionally, businesses that would be treated as a Specified Trade or Business under §199A are disallowed from QSBS treatment under §1202.
5. Noncorporate Taxpayer
Only noncorporate taxpayers can claim the Section 1202 exclusion. Individuals, trusts, and estates qualify. C corporations do not. The treatment of QSBS held by an S corporation or partnership follows a look through principle to the ultimate allocable share of the K-1 recipient, which can require complicated tracing techniques and special allocations with regard to who was treated as recipient of originally issued stock should there be changes in ownership.
Three Changes OBBBA Made
1. Tiered Holding Period with Graduated Exclusions
Before the OBBBA, qualifying taxpayers had to hold QSBS for more than five years to claim any exclusion. The OBBBA replaced that single threshold with a graduated schedule, applicable to stock issued after July 4, 2025:
| Holding Period | Capital Gain Exclusion | Applicable Stock |
|---|---|---|
| At least 3 years | 50% | Issued after July 4, 2025 |
| At least 4 years | 75% | Issued after July 4, 2025 |
| 5 years or more | 100% | Issued after July 4, 2025 |
Important: The unexcluded portion of gain on stock held for three or four years is subject to a 28% capital gains rate, not the standard 15% or 20% long-term rates. That 28% applies to whatever gain isn’t covered by the exclusion, which changes the effective tax math on three- and four-year exits.
Stock issued on or before July 4, 2025, remains subject to the original five-year requirement with no partial exclusion available.
2. Increased Per-Taxpayer Gain Exclusion Cap
Section 1202 limits the amount of gain a taxpayer can exclude per issuer. That cap has always been the greater of two figures: a flat dollar amount, or 10 times the taxpayer’s aggregate adjusted basis in the stock sold.
For stock issued after July 4, 2025, the OBBBA raised the flat dollar component from $10 million to $15 million ($7.5 million for married taxpayers filing separately). The 10x basis cap stays in place. Both are still compared, and whichever is greater applies.
That $15 million figure gets annual inflation adjustments starting in 2027. For stock issued on or before July 4, 2025, the pre-OBBBA $10 million cap still governs even if the sale happens after enactment. Exclusion limits follow the stock’s issuance date, not the sale date.
3. Higher Gross Asset Threshold
The aggregate gross asset ceiling for post-July 4, 2025 stock moved from $50 million to $75 million, with annual inflation adjustments starting in 2027.
Stock issued on or before July 4, 2025 stays under the $50 million threshold. A taxpayer also cannot exchange pre-OBBBA stock for newly issued stock to get the more favorable post-OBBBA treatment. Section 1202(i) is explicit on this: QSBS received in a Section 351 exchange or a tax-free reorganization in exchange for pre-OBBBA stock retains pre-OBBBA treatment.
Effective Date and Pre-OBBBA Stock
The OBBBA changes apply only to QSBS issued after July 4, 2025. Two things follow from that.
Stock issued before or on that date is governed entirely by the old rules: five-year holding period, $10 million gain exclusion cap (or 10x basis), $50 million gross asset threshold. Nothing about the OBBBA changes what applies to that stock.
For stock issued after July 4, 2025, the three-year holding period clock started on the issuance date.
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