Section 1202 QSBS in 2026: Exclusion Limits, Holding Periods, and Eligibility Rules

Written by: TrendSpike Editorial Desk | Published: October 12, 2026 | Jurisdiction: United States (Federal Tax Law)

Internal Revenue Code (IRC) Section 1202 allows eligible noncorporate taxpayers to exclude some or all of the gain from selling Qualified Small Business Stock (QSBS). The amount of gain that may be excluded depends on the stock's acquisition date, holding period, issuer eligibility, the taxpayer's circumstances, and statutory limits. Changes enacted on July 4, 2025, introduced a tiered holding-period benefit and increased certain dollar thresholds for qualifying stock acquired after that date. Because the rules differ between older and newer stock, investors and founders should establish the applicable regime before planning a sale.

1. Determine Which Section 1202 Rules Apply

The acquisition date matters. Public Law 119-21, enacted on July 4, 2025, amended Section 1202. In general, the expanded holding-period benefits and increased dollar limits apply to qualifying stock acquired after July 4, 2025. Stock acquired on or before that date generally remains subject to the prior rules.

• Stock acquired on or before July 4, 2025: The prior holding-period and exclusion rules generally apply. The applicable exclusion percentage can depend on the stock's original acquisition or issuance history under the earlier law.
• Stock acquired after July 4, 2025: The amended rules generally provide a tiered exclusion based on how long the qualifying stock is held, along with an increased per-issuer dollar limit and a higher gross-asset threshold.

Do not determine eligibility from the sale date alone. Review the original issuance, any transfers or conversions, and the holding-period rules under Section 1223 and other applicable provisions.

2. Shareholder Eligibility and Original Issuance

Section 1202 generally benefits taxpayers other than corporations, including eligible individuals and certain trusts, estates, and owners of pass-through entities. Special rules govern partnerships, S corporations, gifts, inheritances, conversions, and other transfers, so eligibility should be assessed for the specific taxpayer and transaction.

Original issuance: The stock generally must be acquired at original issuance directly from the qualifying corporation, or through an underwriter, in exchange for money, property other than stock, or qualifying services. Buying shares from an existing shareholder on a secondary market generally does not satisfy this requirement. Certain transfers and exchanges may qualify under specific statutory rules.

Eligible issuer: The issuer generally must be a domestic C corporation and meet the qualified-small-business requirements at the relevant times. Stock issued by an S corporation or a foreign corporation does not meet the basic issuer requirement.

Holding period: The applicable holding period depends on the stock's acquisition date. For qualifying stock acquired after July 4, 2025, the amended law generally permits a partial exclusion after three years and larger exclusions after four and five years. For older stock, the prior holding-period rules generally continue to apply.

3. Holding Period and Exclusion Percentage

For qualifying stock acquired after July 4, 2025, the amended Section 1202 generally provides the following federal gain-exclusion percentages:

• At least 3 years: 50% of eligible gain.
• At least 4 years: 75% of eligible gain.
• At least 5 years: 100% of eligible gain.

These percentages do not mean that every sale automatically qualifies for the stated exclusion. The stock and issuer must satisfy the applicable QSBS requirements, and the gain remains subject to the relevant statutory limitations and special rules.

For stock acquired on or before July 4, 2025, do not automatically apply the new three-year and four-year schedule. The prior rules generally require a holding period of more than five years for the Section 1202 exclusion, and the percentage available may depend on the stock's historical acquisition or issuance date.

Convertible instruments, SAFEs, and stock options require separate analysis. The date a document is signed, an instrument is funded, or an option is granted does not necessarily establish the date the underlying stock was acquired for Section 1202 purposes.

4. Per-Issuer Exclusion Limits

Section 1202 limits the amount of gain eligible for exclusion for each taxpayer and issuer. The applicable dollar limit and the alternative basis-based limit must be evaluated under the rules that apply to the stock.

• Stock acquired on or before July 4, 2025: The prior dollar limitation generally uses $10 million, reduced by relevant gain exclusions from the same issuer in prior years, or the alternative basis-based limit, whichever is greater.
• Stock acquired after July 4, 2025: The amended law generally increases the dollar limitation to $15 million, subject to the statutory rules and inflation adjustments for taxable years beginning after 2026, or the applicable alternative basis-based limit, whichever is greater.

The alternative basis-based limit generally uses ten times the aggregate adjusted basis of qualifying stock of the issuer disposed of during the taxable year, subject to the detailed statutory calculation. The dollar limit is not a separate, unrestricted allowance for every share sale or every transaction. Prior exclusions, pass-through ownership rules, and other limitations can affect the result.

Investors should calculate the applicable limit using the statute and their own acquisition, basis, ownership, and prior-exclusion records rather than relying on a headline dollar amount.

5. The Corporation's Gross-Asset Test

Under IRC Section 1202(d), the issuer generally must satisfy the qualified-small-business gross-asset test before and immediately after the relevant stock issuance. The applicable threshold depends on the stock's acquisition date under the statutory effective-date rules.

• Stock issued on or before July 4, 2025: The prior $50 million gross-asset threshold generally applies.
• Qualifying stock issued after July 4, 2025: The amended law generally raises the threshold to $75 million.

The corporation generally must not have exceeded the applicable threshold at any time before issuance and must remain within the threshold immediately after issuance, taking into account amounts received in the issuance. Controlled-group and predecessor rules may also affect the calculation.

Asset valuation: The statutory calculation generally takes account of cash and the adjusted tax bases of other property. Certain contributed property is taken into account at fair market value when contributed, as provided by the statute.

A corporation's later growth above the issuance threshold does not, by itself, automatically disqualify stock that already met the issuance test. However, the corporation must continue to satisfy other applicable QSBS requirements, including the active-business requirements during the relevant holding period.

6. The 80% Active-Business Requirement

Under IRC Section 1202(e), during substantially all of the applicable holding period, at least 80% of the corporation's assets, measured by value, generally must be used in the active conduct of one or more qualified trades or businesses. The statute contains detailed rules about qualifying assets, working capital, subsidiaries, and excluded businesses.

Working capital and research assets: Section 1202 contains rules for certain assets held for reasonably required working capital and research and experimentation. These rules have conditions and limitations, including restrictions that can apply as a corporation ages. A company should not assume that all cash, marketable securities, or investment assets count as active business assets.

Excluded trades or businesses: Section 1202(e)(3) excludes specified categories from the definition of a qualified trade or business. These include certain services in fields such as health, law, consulting, financial services, brokerage, and other listed professional fields; banking, insurance, financing, leasing, investing, and similar businesses; farming; specified natural-resource extraction businesses; and operating a hotel, motel, restaurant, or similar business.

The statutory categories contain technical definitions and exceptions. A company's marketing label or industry name alone does not settle whether it qualifies. Review its actual activities, revenue sources, assets, and applicable statutory provisions.

7. Stock Redemptions and Anti-Abuse Rules

Section 1202 contains anti-redemption provisions that can cause stock to fail the QSBS requirements. These rules are particularly relevant when a corporation repurchases shares near an issuance or financing round.

Related-party redemptions: Under Section 1202(c)(3), certain purchases of stock from the taxpayer or a related person during the statutory period surrounding an issuance can disqualify the stock. The provision generally examines a period beginning two years before issuance and ending two years after issuance.

Significant corporate redemptions: A separate rule generally addresses certain corporate stock purchases during the period beginning one year before issuance and ending one year after issuance when the aggregate value of the purchases exceeds the statutory 5% threshold. The calculation and application depend on the statutory definitions and facts.

These provisions should not be reduced to a general statement that every buyback or secondary transaction invalidates all QSBS. The issuer should document the dates, parties, amounts, and nature of any stock repurchases and obtain tax advice where the rules may apply.

8. State Tax Treatment Is Separate

A federal Section 1202 exclusion does not guarantee an equivalent state income-tax exclusion. State treatment varies and may change as state laws are amended. A state's general conformity to parts of the Internal Revenue Code does not, by itself, establish that the state allows the federal QSBS exclusion.

Before a sale, review the law and guidance for the taxpayer's state of residence, the corporation's relevant connections, the tax year, and any applicable state-specific limitations. Do not assume that a federal exclusion eliminates state tax, and do not rely on a general list of conforming or nonconforming states without checking current primary sources.

9. Practical Section 1202 Review Checklist

• Confirm that the issuer is an eligible domestic C corporation and review its business activities.
• Document the stock's acquisition date and determine whether the pre-July 5, 2025 rules or the amended rules apply.
• Verify original issuance and review any gifts, inheritances, conversions, transfers, or pass-through ownership.
• Calculate the applicable holding period and exclusion percentage.
• Check the relevant gross-asset threshold and retain the corporation's balance sheets and issuance records.
• Review whether the corporation met the active-business test during substantially all of the relevant holding period.
• Inspect corporate repurchases and related-party transactions for possible redemption-rule issues.
• Calculate the per-issuer dollar and basis-based limitations, including prior exclusions and applicable inflation adjustments.
• Review the taxpayer's state tax treatment for the relevant year.
• Retain stock certificates, subscription agreements, capitalization tables, tax-basis records, financial statements, and supporting corporate documentation.

Sources and Official References

The following resources provide the statutory and administrative framework for reviewing QSBS eligibility. The applicable law and guidance should be checked for the specific tax year and transaction.

Public Law 119-21 — Section 70431, Expansion of Qualified Small Business Stock Gain Exclusion

Internal Revenue Code Section 1202 — Partial Exclusion for Gain from Certain Small Business Stock

IRS Instructions for Schedule D (Form 1040) — Qualified Small Business Stock Gain

IRS Publication 550 — Investment Income and Expenses

California Franchise Tax Board — Summary of Federal Income Tax Changes

Disclaimer

This article is for general informational and educational purposes only. It is not legal, accounting, investment, or tax advice, and it does not establish an attorney-client or accountant-client relationship. QSBS eligibility and the amount of gain that may be excluded depend on detailed statutory requirements and the facts of each case. Consult a qualified tax professional or tax attorney before relying on Section 1202 in connection with an investment, corporate transaction, or stock sale.