Key insights
- If your stock qualifies, Section 1202 may allow you to exclude a meaningful portion of your gain from federal taxes, which can materially increase what you keep when you eventually sell your business.
- Your eligibility depends on multiple factors, including entity choice, ownership structure, asset use, and business activity, all of which must align with technical rules that can change as your company grows.
- Actions such as equity issuances, redemptions, or operational shifts can affect your qualification, so staying attentive throughout the business lifecycle can help preserve the tax benefits you’re working toward.
- Start planning early, because Section 1202 eligibility is shaped over time through how you structure your business, issue stock, and operate; decisions made years before a sale can significantly affect your outcome.
Build your path to meaningful tax savings.
Section 1202 can be one of the most valuable tax benefits available to founders and investors in growing businesses.
When the requirements are met, it can allow a shareholder to exclude a substantial portion, and in some cases all, of the gain from selling qualified stock.
The One Big Beautiful Bill Act (OBBBA) expanded Section 1202 for stock issued after July 4, 2025. It increased the gross asset threshold to $75 million, raised the gain exclusion cap to $15 million, and introduced a phased benefit for qualifying stock held more than three years.
Section 1202 addresses how gain is treated at exit. With the right structure in place, the impact can be meaningful.
What is Section 1202 and how does the tax benefit work?
When stock in a C corporation is sold, the gain is generally subject to federal capital gains tax.
Section 1202 creates an exception by allowing eligible shareholders to exclude 50%, 75%, or 100% of the gain, depending on when the stock was acquired and, for certain newer stock, how long it’s been held. Stock must have been held for at least five years (three years in the case of stock issued after July 4, 2025) to qualify for the exclusion.
The exclusion is generally capped at the greater of 10 times the shareholder’s tax basis in the stock or $10 million, increased to $15 million for qualifying stock issued after July 4, 2025.
In the right fact pattern, a founder or early investor may be able to exclude a substantial amount of gain, potentially up to 10 times tax basis, subject to the applicable limitations and qualification rules.
State tax treatment also varies, and some states don’t conform to federal rules.
Who qualifies for the Section 1202 exclusion?
Core eligibility requirements
Eligibility depends on requirements at both the corporate and shareholder levels.
In general, the stock must be issued by a domestic C corporation, and the issuing company generally must remain a domestic C corporation for most of the shareholder’s holding period. The shareholder generally must acquire the shares at original issuance in exchange for cash, certain property, or services.
The corporation must have no more than $50 million in gross assets ($75 million for stock issued after July 4, 2025), and at least 80% of the value of its assets must be used in the active conduct of a qualified trade or business. The shareholder must also satisfy the required holding period.
Excluded businesses and ineligible entities
Certain businesses fall outside the rules, including many professional service businesses, financial activities, farming, hospitality, and certain resource-based businesses.
For companies operating near the boundary of an excluded category, the analysis can be fact-specific and technical.
Certain entities, including foreign corporations, DISCs, RICs, REITs, REMICs, and cooperatives, are categorically ineligible.
Ongoing requirements and potential disqualifiers
Qualification is shaped over time, not only when the stock is issued. Certain redemption activity around the issuance date can disqualify otherwise qualifying stock. Changes in how assets are used, ownership transitions, and financing or transaction steps taken years after formation can also affect the result.
In some cases, gain attributable to appreciation already built into contributed property may also be subject to separate limitations, which makes technical review especially important.
Section 1202 planning strategies for founders and investors
Section 1202 can influence entity selection, capitalization strategy, founder equity design, investment timing, ownership transitions, and exit planning. A business that evaluates it early has more room to structure around the rules and document its position over time.
A business that waits until a sale process begins may still have planning opportunities, but the path is often narrower. For founders and investors, that makes Section 1202 part of a broader conversation about how to build enterprise value and retain more of it at exit.
How CLA can help with Section 1202 planning
With the right structure and continued attention, Section 1202 can improve after-tax results when a business is sold. Because the rules are technical and highly fact-specific, tax advisors should be involved before major ownership or transaction decisions are made.
We work with founders, investors, and management teams to evaluate whether Section 1202 applies and how to preserve eligibility as the business grows and ownership evolves.
That includes reviewing entity and ownership structure, analyzing how the business fits within the qualified trade or business rules, evaluating how transactions and redemptions may affect the outcome, and identifying tax planning opportunities that may expand the amount of gain eligible for exclusion.
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