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Section 1202 of the IRS provides specific investors in qualified small businesses to exclude from their taxable income up to 50% of the gain on selling their business shares. This exclusion applies if the company has over five years and the investor has owned the shares for more than 12 months.
An example of how this can impact tax liability will be if an investor sells shares in a qualified small business that they have held for more than five years and owned for more than 12 months. If they sell the shares for $10,000 and the basis (or purchase price) is $6,000, they could exclude $2,000 of the gain from their taxable income.
This provision benefits investors in qualified small businesses by allowing them to keep more profits from these investments.
There are a few primary considerations when it comes to section 1202.
To qualify for the exclusion provided by section 1202, the shares in the qualified small business must meet three requirements:
The first requirement is that the holder must hold the shares for more than five years. This requirement ensures that investors cannot take advantage of the exclusion by quickly selling their shares after they have you’ve acquired them.
The second requirement is that the investor must have owned the shares for more than 12 months. This requirement eliminates the possibility of short-term investors taking advantage of the exclusion.
The final requirement is that the business must engage in a qualifying trade or business. This step means it must meet certain asset and income thresholds to qualify.
Explore our tax planning tools to take the most advantage of your investments. Get started with our calculator. Or access our previous definitions to know more!
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