QSBS Section 1202: Eligibility and the 2025 Changes

A Potential Exclusion With Detailed Eligibility Rules

Section 1202 may let a noncorporate taxpayer exclude some or all gain from eligible Qualified Small Business Stock (QSBS). The result depends on when the stock was acquired, how long it was held, the issuer's facts, the shareholder's facts, and the per-issuer limitation.

For eligible stock acquired after July 4, 2025, the gain limitation is generally the greater of $15 million or 10 times adjusted basis. Eligible stock acquired earlier generally uses a $10 million limit or 10 times adjusted basis. These are not automatic deductions, and the limit has additional taxpayer, spouse, transfer, and prior-disposition rules.

The 2025 OBBBA Changes

Public Law 119-21, enacted July 4, 2025, changed Section 1202 for stock acquired after that date. The acquisition-date limitation matters; the new figures do not automatically apply to older stock.

Increased Exclusion Cap

For qualifying stock acquired after July 4, 2025, the dollar component of the per-issuer limitation increased from $10 million to $15 million. The alternative 10-times-basis calculation still applies.

Increased Gross Asset Limit

For stock issued after July 4, 2025, the issuer gross-asset threshold increased from $50 million to $75 million, measured before and immediately after issuance. Stock issued on or before that date remains subject to the earlier threshold.

Graduated Exclusion Schedule

For qualifying stock acquired after July 4, 2025, the law introduced a graduated exclusion based on holding period:

The new schedule does not retroactively change the holding-period rule for older stock. Older stock can also have a 50%, 75%, or 100% exclusion percentage based on its original acquisition date under prior versions of Section 1202.

Eligibility Requirements

To qualify for the QSBS exclusion, all of the following must be true:

1. C-Corporation Stock

The company must be organized as a C-corporation (not an LLC, S-corp, or partnership) at the time the stock is issued and during substantially all of the holding period. Most venture-backed startups are C-corps.

2. Active Business Requirement

The corporation must use at least 80% of its assets, by value, in the active conduct of one or more qualified trades or businesses during substantially all of the holding period. Section 1202 excludes several categories of businesses. A company being a “technology startup” is not enough to establish qualification.

3. Applicable Gross-Asset Test

For stock issued after July 4, 2025, aggregate gross assets generally must not exceed $75 million before and immediately after issuance. The earlier $50 million threshold generally applies to stock issued on or before that date. Contributions for the issuance count in the post-issuance test.

4. Original Issuance

You must have acquired the stock at original issuance — directly from the company, not from another stockholder on a secondary market. Stock acquired through exercising stock options qualifies, as does stock received through RSU vesting (subject to certain conditions). Stock purchased on the secondary market does not qualify.

5. Holding Period

For qualifying stock acquired after July 4, 2025, more than 3 years can support a 50% exclusion, more than 4 years a 75% exclusion, and more than 5 years a 100% exclusion. The stock-acquisition date for an option exercise and the effect of restricted shares or an 83(b) election can be fact-specific.

How It Works in Practice

Example

Assume you acquire otherwise qualifying stock after July 4, 2025 by exercising options:

• Exercise price: $1 per share
• Number of shares: 100,000
• Total cost: $100,000
• 10x basis exclusion: $1,000,000

Five years later, the company goes public and you sell:

• Sale price: $50 per share
• Total proceeds: $5,000,000
• Capital gain: $4,900,000

If QSBS applies:

• The $4.9 million gain is below the $15 million dollar limitation in this simplified example.
• The 10-times-basis amount is $1 million, so the greater-of test uses the $15 million amount—not both amounts.
• A complete return analysis must still confirm every issuer, shareholder, holding-period, transfer, prior-sale, and reporting requirement.

The 10x Basis Rule

For eligible stock acquired after July 4, 2025, the limitation generally uses the greater of $15 million or 10 times adjusted basis. For eligible stock acquired earlier, the dollar amount is generally $10 million. Prior eligible dispositions from the same issuer and special basis rules can change the available amount.

State Conformity

State conformity and state capital-gain rules vary and can change independently of federal law. Confirm the rules for every jurisdiction that could tax the sale instead of assuming the federal exclusion controls the state result.

Strategies for Maximizing QSBS Benefits

Exercise Early

An option holder generally acquires stock on exercise, but restricted-stock and transfer facts can affect the tax analysis. Exercising earlier starts ownership sooner but also creates investment, tax, forfeiture, and illiquidity risks. QSBS should not be the only reason to exercise.

File an 83(b) Election

An 83(b) election for substantially nonvested shares can affect when tax and holding periods begin. Its 30-day deadline and the interaction with Section 1202 require advice based on the grant and exercise documents.

Per-Issuer Limit

Section 1202 applies a lifetime gain limitation per taxpayer and issuer, with special rules for spouses, joint returns, prior dispositions, and transfers. Do not assume marriage doubles the limitation.

Gifting Strategies

Certain gifts can preserve QSBS status, but basis, holding period, limitation, gift-tax, trust, anti-abuse, and assignment-of-income rules can materially affect the result. Do not transfer shares to “stack” exclusions without specialized legal and tax advice.

Common Pitfalls

Secondary Market Sales Break QSBS

If you sell QSBS shares and then use the proceeds to buy shares from another holder, the new shares do not qualify for QSBS (they were not acquired at original issuance).

Company Becoming Too Large

Apply the gross-asset threshold in effect for the stock's acquisition date and obtain issuer records. A capitalization estimate or 409A value alone does not establish the Section 1202 gross-asset test.

Insufficient Holding Period

For stock acquired after July 4, 2025, the graduated schedule begins only after more than three years. Different acquisition-date rules apply to older stock, and Section 1045 may be relevant to some sales after more than six months.

The Bottom Line

QSBS can materially change federal tax on a qualifying sale, but eligibility is technical and requires contemporaneous issuer and shareholder records. State treatment varies. Have a qualified tax professional review the acquisition date, issuer qualification, holding period, transfers, prior dispositions, and proposed sale before relying on an exclusion.