QSBS (IRC 1202): How to Exclude Up to $10 Million of Capital Gains on Small Business Stock

By Yarik Yarosh, CPA ·September 5, 2026 ·8 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Section 1202 is the most valuable tax provision for startup founders and early investors. Under IRC 1202, a non-corporate taxpayer who holds qualified small business stock (QSBS) for at least 5 years can exclude 100% of the gain on sale, up to the greater of $10 million or 10 times their adjusted basis in the stock. For stock acquired after September 27, 2010, the exclusion rate is 100%, meaning the gain is completely exempt from federal income tax and the 3.8% NIIT. On a $10 million gain, that is $2,380,000 in federal tax savings (at 23.8% combined LTCG + NIIT). The exclusion applies per shareholder, per issuer, so a married couple filing jointly who each own qualifying stock can exclude up to $20 million of gain. The requirements are specific: the corporation must be a domestic C-Corporation (not an S-Corp, LLC, or partnership), its aggregate gross assets must not exceed $50 million at the time of issuance and immediately after, and the stock must be acquired at original issuance in exchange for money, property, or services (not purchased on the secondary market).

✓Key takeaway

IRC 1202 QSBS requirements:

Requirement	Details
Entity type	Domestic C-Corporation (not S-Corp, LLC, or partnership)
Gross asset limit	$50 million or less at time of issuance AND immediately after
Stock acquisition	Original issuance for money, property (other than stock), or services
Holding period	At least 5 years
Active business test	At least 80% of assets used in qualified trade or business
Exclusion amount	Greater of $10 million or 10x adjusted basis per shareholder per issuer
Exclusion rate (post-9/27/2010)	100% (no federal capital gains tax)
NIIT	Also excluded from the 3.8% net investment income tax
AMT	No AMT preference item for stock acquired after 9/27/2010

Excluded (non-qualifying) businesses:

Business Type	QSBS Eligible?
Technology / Software	Yes
Manufacturing	Yes
Retail	Yes
Construction	Yes
Healthcare services (physician, dentist, etc.)	No
Law firm	No
Accounting firm	No
Engineering firm	No
Financial services	No
Consulting	No (unless non-personal service)
Banking / Insurance	No
Farming	No
Hotel / Restaurant	Yes
Mining / Oil & Gas	No
Any business where principal asset is reputation/skill of employees	No

The $50 million gross asset test:

Counts Toward $50M	Doesn’t Count
Cash and cash equivalents	N/A
Property (at adjusted basis, not FMV)	N/A
Total aggregate gross assets of the corporation
Measured at time of issuance AND immediately after

How does the QSBS exclusion work in practice?

Hypothetical example

Round numbers. A founder starts a C-Corporation in 2020, investing $100,000 in exchange for 100% of the stock. The company develops software (a qualifying business). By 2026, after more than 5 years, the founder sells the company for $8,000,000.

QSBS exclusion calculation:

Item	Amount
Sale price	$8,000,000
Founder’s basis in stock	$100,000
Gain	$7,900,000
Exclusion limit: greater of $10M or 10x basis ($1M)	$10,000,000
Gain excluded (100% of $7,900,000, within $10M limit)	$7,900,000
Taxable gain	$0
Federal tax	$0
NIIT	$0
Total tax savings	$1,880,200 (vs. $7.9M x 23.8% = $1,880,200)

What if the sale price is $15,000,000?

Item	Amount
Gain	$14,900,000
Exclusion (capped at $10,000,000)	$10,000,000
Taxable gain	$4,900,000
Tax on taxable gain (23.8%)	$1,166,200
Tax savings from exclusion ($10M x 23.8%)	$2,380,000

Stacking the exclusion with multiple shareholders: If the founder brings in a co-founder (also at original issuance):

Shareholder	Basis	% Ownership	Share of $15M Sale	Gain	Exclusion (each gets $10M)	Taxable	Tax
Founder A	$100,000	60%	$9,000,000	$8,900,000	$8,900,000	$0	$0
Founder B	$50,000	40%	$6,000,000	$5,950,000	$5,950,000	$0	$0
Combined			$15,000,000	$14,850,000	$14,850,000	$0	$0

Each shareholder has their own $10M exclusion. Two founders can exclude up to $20M combined. A married couple where both spouses hold QSBS (each received stock at original issuance) can also each claim the full exclusion.

IRC 1202 rollover (Section 1045): If a QSBS holder sells before the 5-year holding period, they can defer gain by rolling over into replacement QSBS within 60 days:

Element	Details
Sale before 5 years	Gain is normally taxable
Section 1045 rollover	Defer gain by purchasing replacement QSBS within 60 days
Holding period	Tacks (original holding period carries over)
Replacement QSBS	Must meet all QSBS requirements
Basis	Reduced by deferred gain

Planning strategies to maximize QSBS:

Strategy	How It Works
Start as C-Corp (not LLC)	QSBS requires C-Corp from the beginning; converting an LLC to C-Corp may work but the holding period restarts
Keep gross assets under $50M	Monitor asset growth; issue stock while below the threshold
Multiple entities	Each C-Corp can issue its own QSBS with its own $10M exclusion per shareholder
Gift QSBS to family	Each donee gets their own $10M exclusion; gifted shares keep the donor’s holding period
Trust holdings	Certain trusts can hold QSBS and claim the exclusion
10x basis strategy	Contribute more property (at FMV) for stock to increase basis; 10x basis can exceed $10M
Section 1045 rollovers	Chain multiple QSBS investments to defer gains and extend holding periods

State QSBS treatment (varies significantly):

State	QSBS Treatment
Federal	100% exclusion (post-9/27/2010 stock)
California	Doesn’t conform; QSBS gain is fully taxable at state level (up to 13.3%)
New York	Doesn’t conform; fully taxable at state level
Texas, Florida, Nevada, Wyoming, Washington	No state income tax; QSBS not relevant at state level
Many other states	Conform to federal exclusion (varying degrees)

For a California resident selling $10M of QSBS:

Tax	Amount
Federal tax	$0 (100% excluded)
California state tax ($10M gain x 13.3%)	$1,330,000
Total tax	$1,330,000

This is why some founders move to no-income-tax states before a QSBS sale.

Common QSBS traps:

Trap	Why It Matters
Starting as LLC then converting	Holding period may restart; QSBS requires C-Corp stock from issuance
S-Corp election	S-Corp stock is NOT QSBS; electing S-Corp status disqualifies the stock
Buying stock on secondary market	QSBS must be acquired at original issuance; secondary purchases do not qualify
Exceeding $50M gross assets	Stock issued after assets exceed $50M does not qualify (but stock issued before remains qualified)
Personal service businesses	Health, law, accounting, engineering, consulting, financial services are excluded
Stock redemptions	Significant redemptions by the corporation can disqualify previously issued QSBS
Holding period	Must hold for at least 5 years; selling at 4 years 11 months forfeits the exclusion

Illustrative numbers only, not a real client and not advice for your facts.

What are the requirements to qualify for the QSBS exclusion?

Section 1202 allows up to 100% exclusion of gain on the sale of Qualified Small Business Stock, but the requirements are strict. The stock must be issued by a domestic C-Corporation with gross assets of $50 million or less at the time of issuance and at all times before the stock was issued. You must acquire the stock at original issuance (not on the secondary market) in exchange for money, property, or services. You must hold the stock for at least 5 years. The corporation must use at least 80% of its assets in an active trade or business (not investment management, banking, insurance, farming, mining, or hospitality), and it must remain a C-Corporation during substantially all of your holding period.

Related guides:

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Cite this page

Yarik Yarosh, CPA. "QSBS (IRC 1202): How to Exclude Up to $10 Million of Capital Gains on Small Business Stock." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-qsbs-qualified-small-business-stock-irc-1202

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.