5.7 Deferring or Excluding Gain on Small Business Stock Investment
To encourage investments in certain “small” businesses, the tax law provides special tax benefits.
Rollover of gain from sale of qualified small business stock (QSB stock).
Gain on the sale of qualifying small business stock (QSB stock) held for more than six months may be rolled over tax free to other QSB stock. The rollover must be made within 60 days of the sale. To qualify as QSB stock, the stock must be stock in a C corporation (not S corporation) that was originally issued after August 10, 1993. The gross assets of the corporation must have been no more than $50 million at all times after August 9, 1993, and before issuance of the stock, as well as immediately after issuance of the stock. An active business requirement must also be met. You must have acquired the stock at its original issue, as a gift or inheritance from a qualifying transferor, or in a conversion of other qualified stock. See the Schedule D instructions and IRS Publication 550 for further QSB requirements.
If the sale proceeds exceed the cost of the replacement stock, your gain is taxed to the extent of the difference. The basis of the replacement stock is reduced by the deferred gain.
To elect deferral, report the sale on Part I (short-term gain) or Part II (long-term gain) of Form 8949. Enter code “R” in column (b) and enter the deferred gain as a negative adjustment in column (g).
Generally, the election to defer gain must be made by the due date or extended due date for your return. If you timely file your original return without the election, the election may be made on an amended return filed no more than six months after the original due date.
Law Alert
Exclusion of gain on small business stock (Section 1202 exclusion).
If you sold qualified small business stock (QSB stock, as defined above) in 2012 after holding it more than five years, only 50% of the gain is taxable. If you qualify for the exclusion, report the sale in Part II of Form 8949. Enter code “S’ in column (b) and enter the excluded 50% of the gain as a negative adjustment in column (g). If you have a net capital gain (net long-term gain in excess of net short-term loss, if any) on Schedule D, the amount of the exclusion is included on the 28% Rate Gain Worksheet in the Schedule D instructions (5.3).
There is an annual and lifetime limit on the Section 1202 exclusion for QSB stock from any one issuer. For 2012, the amount of gain from any one issuer that is eligible for the 50% exclusion (or 60% exclusion for empowerment zone business stock if legislation is enacted as discussed below) is limited to the greater of (1) 10 times your basis in the qualified stock that you disposed of during 2012, or (2) $10 million ($5 million if married filing separately) minus any gain on stock from the same issuer that you excluded in prior years.
Will there be a 60% exclusion for stock in an empowerment zone business? A 60% exclusion (instead of 50%) applied before 2012 to gain on the sale of QSB stock acquired after December 21, 2000 and before February 18, 2009, and which was held for more than five years in a corporation that qualified as an empowerment zone business. However, the law authorizing the designation of an area as an empowerment zone expired at the end of 2011. Without an extension of the law, there will be no empowerment zone designations in effect during 2012 and thus on a 2012 sale only the regular 50% exclusion will be available; the increase to 60% will not be allowed. See the e-Supplement at jklasser.com for an update, if any, on an extension of the 60% exclusion rules to sales after 2011.
Rollover from publicly traded securities to SSBIC.
You may be able to defer taxable gain on the sale of publicly traded securities provided the sale proceeds are rolled over within 60 days into common stock or a partnership interest in a “specialized small business investment company,” or SSBIC. An SSBIC is a partnership or corporation licensed by the Small Business Administration to invest in small businesses that are owned by socially or economically disadvantaged individuals. Subject to the deferrable limit, the entire gain is deferrable if the cost of your SSBIC stock or partnership interest is at least equal to the sale proceeds. If the SSBIC investment is less than the sale proceeds, your gain is taxed to the extent of the difference. The deferred gain reduces the basis of your SSBIC stock or partnership interest.
There is an annual and lifetime limit on the deferrable gain. The deferrable limit each year is limited to the smaller of (1) $50,000, or $25,000 if you are married filing separately, or (2) $500,000, or $250,000 if married filing separately, minus any gains deferred for all prior years.
To elect deferral, you must report the sale on Form 8949. In column (b) enter code “R” and in column (g) enter the deferred gain as a negative adjustment. Also attach an explanation detailing the SSBIC investment.