This is the archive of CPA Now blogs posted on the PICPA website through April 30, 2025. Want more recent blogs?
Tax-Free Investing? Is That Possible?
Section 1045 of the tax code allows a taxpayer who has held an investment in qualified small business stock for at least six months to defer the capital gains tax if they roll over the proceeds from the sale of this stock.
By Guest Blogger John Steffee, CPA
Congratulations! Your investment in the stock of a small company has paid off, and you’ve realized a very nice capital gain. The U.S. Treasury is also excited about your success. So much so that it would like to participate in the rewards of your good fortune and hard work.
If you’d rather not include Uncle Sam in your good fortune, there may be a way to either defer payment or, in some circumstances, pay only a portion of the taxes due. If things really work out, maybe nothing at all.
Section 1045 of the tax code allows a taxpayer who has held an investment in qualified small business stock for at least six months to defer the capital gains tax if they roll over the proceeds from the sale of this stock into the stock of another qualified small business within 60 days of the sale of the initial investment. The cost basis in the replacement stock must be reduced by the deferred Section 1045 capital gain.
Here are characteristics of qualified small business stock:
- Stock in a domestic C corporation with no more than $50 million in assets at the time of issuance.
- The corporation uses at least 80 percent of its assets in an active trade or business.
- Stock must be original issue stock that was issued after Aug. 10, 1993.
- Corporation may not be engaged in the performance of services such as health, law, engineering, etc. Banking, finance-related, and farming operations are similarly excluded.
Section 1202 of the tax code may be even better. It allows a taxpayer who has held an investment in a qualified small business for at least five years to exclude from 50 percent to 100 percent of capital gain, depending on when the original investment was made.
The use of either Section 1045 or Section 1202 involves some intricate and detailed steps. If you find yourself in this situation, it is in your best interest to consult with a CPA or attorney familiar with these transactions to make sure your Section 1045 income deferral or Section 1202 income exclusion has complied with all the applicable tax rules.
John Steffee, CPA, is a partner in the public accounting firm Simon Lever LLP in Lancaster, Pa. Steffee specializes in tax planning for small businesses and individuals.
