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Key Takeaways:
- The new tax bill introduces a graded holding period for QSBS, with gain exclusions based on how long shares are held.
- The fixed gain exclusion under Section 1202 increases from $10 million to $15 million for qualifying shares issued after July 4, 2025.
- The asset cap for calculating the 10X adjusted basis exclusion rises from $50 million to $75 million, expanding potential gain exclusions for shareholders.
The One Big Beautiful Bill Act, signed into law July 4, 2025, makes three significant changes to Section 1202. These changes affect the five-year holding period required and the amounts of gain exclusion under the law.
Here are answers to frequently asked questions about these changes:
How was the holding period requirement revised?
Under prior law — and for qualified small business stock (QSBS) shares prior to the Act taxpayers must hold QSBS shares for five years from the date of issue for any gain exclusion which is 100%.
For QSBS shares issued after the date of the new law, there is a so-called "graded" holding period. Thus, if you hold shares for three years from the date of issue, the gain exclusion is 50%. If four years from the date of issue, the gain exclusion is 75%. If shares are held for five years, which is consistent with prior law, the gain exclusion is the longstanding 100%.
This change affects both the holding period and the amount of gain excluded depending on the applicable holding period achieved.
Has the gain exclusion increased under the new law?
Yes, Section 1202 gain exclusion is based upon the greater of (a) $10 million (the "fixed" amount) or (b) 10 times adjusted basis in the qualifying QSBS shares (the "10X" amount). The new law makes changes to both elements of this gain exclusion calculation.
What is the change to the $10 million exclusion?
For qualifying shares issued after the enactment date of the new law, the "fixed" gain exclusion amount is now $15 million. Further, this $15 million amount is indexed for inflation for years beginning after 2026.
What is the change to the 10X adjusted basis gain exclusion?
The 10X exclusion provision involves the fair market value of the QSBS corporation's assets at the time it issues qualifying shares. If the assets at this date are valued at, hypothetically, $27 million, then the 10X adjusted basis element yields an aggregate gain exclusion of $270 million for all shareholders.
Existing law was based on an asset cap of $50 million. The new law increases that cap to $75 million. Thus, hypothetically, if a corporation had an asset valuation upon conversion after the passage of the new law of $69 million, the aggregate gain exclusion for shareholders would be $690 million. This example reflects an increase in total gain exclusion by $190M over the prior maximum exclusion of $500M.
Like the $15 million element of gain exclusion, this asset provision is also indexed for inflation for years after 2026.
What New Section 1202 Changes Mean for You
These increases in gain exclusion expand the number of eligible entities that may consider a 1202 conversion. The increases also offer a significant expansion of the basic gain exclusion and continued adjustment upwards due to inflation indexing.
These are positive changes for development stage enterprises, the capital allocation flowing to them, and the entrepreneurs and investors involved in such businesses.
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.
