Excluding 50% of Gain on Qualified Small Business (QSB) Stock-Section 1202

Tax policy is enacted for a variety reasons. Sometimes with a social purpose in mind, such as a tax on cigarettes to encourage people to stop smoking.

Other times, tax policy has an economic purpose in mind, such as encouraging investment in small businesses. This is the purpose of the Section 1202 50% gain exclusion.

The catch is, you must hold the stock over five years to qualify for the 50% gain exclusion. The idea is to encourage investment and not speculation.

If you have a gain on the sale of qualified small business stock held over five years, only 50% of the gain is taxed.

If you have a net capital gain (a net long-term gain in excess of a net short-term loss, if any), 50% of it is subject to a 28% capital gain rate. The remaining 50% is tax free.

In other words, you may exclude 50% of the gain from being taxed when you sell qualified small business stock held over five years.

For example, if your gain is $10,000 only $5,000 is subject to taxes, the other $5,000 is tax free.

Qualifying empowerment zone business stock:

The Department of Housing and Urban Development and Agriculture has designated a variety of cities and rural economically distressed areas as empowerment zones.

The percentage of the gain that may be excluded on the sale of stock held more than five years in a corporation that qualified as an empowerment zone business is 60%.

To find out what areas are designated as empowerment zones go to: www.hud.gov/crlocator.

The rules for Taking the 50% (or 60%) Gain Exclusion

  • The stock being sold must have been issued after August 10, 1993.
  • You must have held the stock more than five years before the sale.

File your personal and small business taxes (Schedule C)