United States: Get A Hold Of Your QSBS Holding Period

As originally enacted in 1993, Section 1202 of the Internal Revenue Code introduced a 50 percent exclusion from taxable gain (with certain limitations) on the sale of so-called "qualified small business stock" (QSBS) held by an individual for more than five years.1 IRC Section 1202 was subsequently amended to provide an increased exclusion of 75 percent for QSBS acquired after Feb. 17, 2009 and before Sept. 28, 2010 (the 75 percent exclusion period), and a 100 percent exclusion for QSBS acquired after Sept. 27, 2010 (the 100 percent exclusion period, and together with the 75 percent exclusion period, the increased exclusion periods). The increased exclusion periods substantially improved the potential tax benefits of owning QSBS and with it, the importance of understanding the holding period rules that apply in the context of QSBS.

QSBS treatment can be immensely valuable for entrepreneurs and early-stage investors, and the availability of the increased exclusion periods has only raised the stakes. However, the complex financial arrangements sometimes used to capitalize start-ups and compensate their employees can raise difficult questions about a shareholder's holding period for QSBS purposes, which could affect not only the exclusion period that might apply to a particular shareholder, but also whether the shareholder qualifies for QSBS treatment at all. Additionally, although gain excludable for each taxpayer under Section 1202 is capped at the greater of $10 million or 10 times starting basis, it should be possible to multiply the capped excludable amount through certain structuring (see "Multiplying the Excludable Amount", p. 40).

Holding Period Rules

In general, the rules for determining when stock is treated as acquired and how long it's held (that is, the holding period) are controlled by IRC Section 1223, which provides for "tacked" (that is, carried over) holding periods whenever a taxpayer converts or exchanges one capital asset for another in a tax-free transaction. However, Section 1202 provides for a series of specific holding period rules, and in certain cases, these rules appear to modify the general holding period (GHP) rules. The primary QSBS holding period rule that diverges from the GHP rules is included in Section 1202(i)(1)(A), which provides that when a taxpayer transfers property (other than money or stock) to a corporation in exchange for QSBS, the holding period for the acquired stock begins on the date of the exchange (the non-stock, non-cash exchange rule (NSNC exchange rule)).2 Other holding period rules included in Section 1202 (such as rules with respect to convertible stock and stock-for-stock exchanges) simply support the same results that would be reached under the GHP rules.

As a result of the inclusion of special holding period rules that apply only in the context of QSBS interests, there's some uncertainty as to the extent to which the GHP rules apply when there's no specific QSBS rule on point. This uncertainty was reduced when Section 1202 was amended in 2012 to provide that the GHP rules should be applied in certain instances when a taxpayer qualifies for one exclusion period under the QSBS holding period rules and a different exclusion period under the GHP rules.

Let's look at the extent to which the GHP rules and the QSBS holding period rules are consistent or differ with respect to common investment methods for early-age investors, including; (1) an option to acquire stock; (2) debt that's convertible to stock (3) preferred stock that's convertible to common stock in the same corporation; (4) tax-free exchanges of stock in one corporation For stock in another corporation; and (5) the conversion of a partnership for U.S. tax purposes into a corporation. We'll also examine the extent to which the GHP rules may be applied in the QSBS context in light of the 2012 amendments and outline the strengths and limitations of two potential readings of such amendments.

Comparison of Rules

Options. The GHP rules treat stock acquired by the exercise of an option to acquire such stock as held from the date of exercise of the option.3 Consistent with the general rule, the legislative history of Section 1202 indicates that stock acquired through the exercise of an option to acquire such stock is treated as acquired for QSBS purposes on the date of exercise of the option.4

Convertible debt. Under the GHP rules, guidance from the Internal Revenue Service confirms that stock received on conversion of a debt instrument should retain the holding period of the debt instrument. In Revenue Ruling 62-140, the taxpayer surrendered convertible debt and paid additional cash in exchange for stock of the debtor. The IRS found that a pro rata portion of the stock received in exchange for the debt instrument retained the holding period of the debt instrument, and the pro rata portion of the stock received in exchange for the cash had a new holding period starting on the date of the conversion.5

In contrast to the general rules, the above-noted NSNC exchange rule should apply to treat stock received in exchange for convertible debt as acquired on the conversion date because the stock is received in exchange for the debt, which is property other than stock or cash. This reading of the NSNC exchange rule is supported by the legislative history to Section 1202, which provides that stock acquired by the taxpayer through the conversion of convertible debt is treated for QSBS purposes as acquired at the date of conversion, and the holding period of the debt doesn't tack to the stock.6

Convertible stock. Under the GHP rules, similar to the above rule for convertible debt, the IRS found in Rev. Rul. 62-153 that the holding period of convertible preferred stock will tack to the common stock received on conversion. Similar to convertible debt, a pro rata portion of the stock received in exchange for any additional cash paid should have a new holding period starting on the date of the conversion:7

Consistent with the general rules, Section 1202(f) provides that for QSBS purposes, if any stock in a corporation is acquired solely through the conversion of other stock in such corporation that's QSBS in the hands of the taxpayer, the acquired stock is also treated as QSBS and treated as acquired on the same day as the old stock.8 This conclusion is supported try legislative history providing that in the case of convertible preferred stock, the holding period is added to that of the common stock acquired on conversion.9

Tax-free stock reorganizations. The GHP rules provide that stock received in exchange for stock in another corporation in a tax-free exchange (such as under IRC Sections 351 or 368) retains the holding period of the relinquished stock.10 Consistent with the general rule, Section 1202(h)(4)(A) provides that for QSBS purposes, the holding period tacks in the case of QSBS exchanged for stock of another corporation (that isn't QSBS) in a transaction described under Section 351 or 368.11

Partnership entering into corporate form. Rev. Rul. 84-111 prescribes three general forms that a partnership converting to a corporation may adopt for tax purposes: (1) a partnership contributes its assets to a new corporation in exchange for stock and distributes such stock to its partners in liquidation (assets over); (2) a partnership distributes its assets and liabilities to its partners in liquidation, and the partners contribute the liquidated partnership's assets and liabilities to a new corporation in exchange for its stock (assets up and over); and (3) partners to a partnership contribute their partnership interests to a new corporation in exchange for its stock, and the partnership distributes its assets and liabilities in liquidation to the new corporation (interests over).

In the case of a partnership conversion taking the form of assets over or assets up and over, the partners' holding period in capital assets and Section 1231 assets (generally depreciable property used in a business and amortizable intangibles) tacks to the new stock received. However, to the extent stock received is attributable to other assets of the partnership (such as account receivables and inventory property), the holding period for stock attributable to such assets will commence on the day following incorporation. Similarly, in the case of a conversion adopting the form of interests over, the partners' holding period generally tacks except for the portion of partnership interests relating to so-called "IRC Section 751 hot assets" (generally unrealized receivables and inventory property). The holding period for stock attributable to such hot assets will commence on the day following incorporation.12

In contrast to the general rules, the above-noted NSNC exchange rule should apply to a partnership conversion to a corporation because such a conversion is generally viewed as a contribution of property (either partnership assets or partnership interests) to a newly formed corporation in exchange for its stock. As such, all stock received should be treated as acquired on the conversion date, and no tacking of the holding period should occur.

In summary, the GHP rules are consistent with the QSBS holding period rules with respect to options, convertible stock and tax-free reorganizations. However, as a result of the NSNC exchange rule, the QSBS holding period rules conflict with the GHP rules in the case of convertible debt and partnership conversion to a corporation.

Alternative Readings

Section 1202 was amended in 2012 to require the application of Section 1223 in certain instances. Specifically, Section 1202(a)(3) was amended to provide that Section 1223 should be applied to determine the acquisition date of QSBS when following 2-part test is satisfied: the stock (1) would be considered acquired during the 75 percent exclusion period applying the rules of Section 1202, and (2) wouldn't be considered acquired during the 75 percent exclusion period applying the GHP rules of Section 1223 (the (a)(3) flush language amendment). An identical provision was added to Section 1202(a)(4) for purposes of determining whether stock is acquired during the 100 percent exclusion period (the (a)(4) flush Language amendment, and together with the (a)(3) flush language amendment, the flush language amendments).

Under a plain reading of the flush language amendments, the GHP rules should apply broadly to measure the holding period of QSBS when the 2-part test is satisfied and would override any special QSBS holding period rule, particularly the NSNC exchange rule. To illustrate the consequences of this reading, if an individual contributed property to a partnership on March 1, 2009, and on Oct. 10, 2010, such partnership converted to a corporation treated as a qualified small business for purposes of Section 1202, the stock received on conversion would be treated as acquired on March 1, 2009 under the GHP rules and acquired on Oct. 10, 2010 under the QSBS holding period rules. If a plain reading is adopted, the acquisition date of the QSBS would be based on the GHP rules, and the taxpayer would qualify for the 75 percent exclusion period instead of the 100 percent exclusion period. Legislative history suggests, as an alternative reading, that the 2012 amendments may have a more limited application.

Section 1045 generally provides that a taxpayer who holds QSBS may sell such stock for cash and avoid current taxation if the sale proceeds are used to purchase alternative QSBS within a certain period of time. Under the GHP rules, Section 1223(13) provides that the holding period for stock acquired in a Section 1045 transaction includes the holding period of the old stock. Prior to the 2012 amendments, there was some uncertainty as to whether the GHP rules applied to determine the acquisition date for QSBS purposes such that the holding period of the relinquished QSBS tacked to the new QSBS in a Section 1045 QSBS rollover to whether special rules in the QSBS context required a different result.

The Senate committee report suggests that the flush language amendments were enacted to clarify that Section 1223(13) should apply in the QSBS context when the 2-part test is satisfied and thus shuts down the opportunity for taxpayers to use a QSBS rollover to achieve a higher exclusion period." Moreover, the "General Explanation' published by the Joint Committee on Taxation states that the flush language amendments' reference to Section 1223 isn't intended to change the acquisition date of QSBS as determined under the NSNC exchange rule.'"

Based on the legislative history, the Flush language amendments may be read to require the application of the GHP rules "subject to" the QSBS holding period rules (that is, only when Section 1202 doesn't otherwise provide a special holding period rule). Because Section 1223(13) doesn't conflict with any of the QSBS holding period rules (that is, replacement QSBS stock is purchased with cash and thus the NSNC exchange rule doesn't apply), this interpretation would be consistent with the application of the GHP rules "subject to" the QSBS holding period rules. Under this alternative reading, stock received on conversion of the partnership in the preceding example would continue to be treated as acquired on Oct. 10, 2010, and the 100 percent exclusion period would apply, because the NSNC exchange rule conflicts with the GHP rules.

The fact that application of the GHP rules under a plain reading of the 2-part test can lead to results that appear inconsistent with the QSBS rules as a whole lends additional support to the alternative reading. Based on our expertise, this ambiguity is particularly acute in the context of QSBS stock acquired on incorporation of a partnership or other non-corporate entity for the following reasons: (1) the holding period of new stock received may relate not only to the holding period in pre-conversion partnership interests, but also to the holding period in pre-partnership formation assets: (2) the holding period in the partnership interests may only tack to a portion of the stock received (depending on whether the partnership holds account receivables, inventory property or hot assets) and may result in different QSBS exclusion percentages for different blocks of stock received in the same transaction; (3) the fact that QSBS may be treated as held prior in the existence of the corporation to be classified as the qualified small business appears to be counter to the intent identified in the statute to limit application of the statute to business enterprises in corporate form.

In summary, there are two alternative readings of the extent to which Section 1223 may apply in determining the acquisition date of stock for purposes of Section 1202 when the 2-part test is satisfied (1) the entirety of Section 1223 applies and overrides the QSBS holding period rules, or (2) Section 1223 is applied subject to the QSBS holding period rules (and Section 1223(13) applies because it's consistent with the NSNC exchange rule). Although a plain reading of the flush language amendments suggests a broad application of Section 1223, the legislative history supports the more sensible view that the GHP rules should apply subject to the existing holding period framework of Section 1202.

Originally appeared in the December 2016 issue of Trusts & Estates.


1. A corporation seeking treatment as a qualified small business must meet several requirements. This article focuses solely on the shareholder requirement to hold stock in a corporation that's treated as qualified small business stock for at least five years.

2. Internal Revenue Code Section 1202(i)(1)(A).

3. IRC Section 1223(5), Treasury Regulations Section 1.1223-1(f).

4. H.R. Rep. NO. 103-11 (1993)

5. IRC Section 1223(1), Revenue Ruling 62-140.

6. See supra note 4.

7. IRC Section 1223(1), Rev. Rul. 62-153

8. IRC Section 1202(f)(1)-(2)

9. See supra note 4.

10. IRC Section 1223(1)

11. IRC Section 1202(h)(4)(A).

12. IRC Section 1223(1), Rev. Rul. 84-111.

13. S. Rep. No. 112-208 (2012), at footnote 159.

14. Staff of the Joint Committee on Taxation, "General Explanation of Tax Legislation Enacted in 112th Congress," at footnote 159.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.