QSBS 1045 Exchange
If your QSBS is sold before meeting the 5-year holding period, you can consider rolling the gains into a new QSBS investment using a 1045 exchange to maintain QSBS eligibility.
Strategy Overview
One of the requirements of QSBS is holding the stock for a period of at least 5 years. But in some circumstances, this is either not feasible or unreasonable. In circumstances where you exit an otherwise QSBS-qualifying position prior to meeting the 5-year holding period, one tax strategy you can consider is a 1045 exchange. This provision allows you to rollover gains from the sale of QSBS into a new QSBS investment, and by doing so, effectively continue with your investment tracking towards the 5-year holding period.
Tax Details
QSBS has many requirements that need to be met in order to qualify. Even if your investment meets all other criteria, if you sell the position prior to holding it for 5 years, QSBS will not be achieved and capital gains tax will be owed.
In some circumstances, this could be due to an action you took (e.g. desire/need to diversify), and in other circumstances it could be outside of your control (e.g. your company is acquired for cash and you're forced to sell). And the resulting tax impact could be very large; potentially as much as 34% across federal and state taxes.
If you find yourself in this situation, one choice you likely have is to consider a Section 1045 exchange. Section 1045 allows you to "rollover" or exchange from one QSBS investment to another, deferring capital gains tax and continuing the clock towards the required 5-year holding period.
Implementing a 1045 exchange has challenges, however, and requires careful planning: After the sale of your original QSBS, you have a 60-day window to identify and invest in a new QSBS holding. The capital gains from the sale of your original QSBS are then "rolled over" into this new investment.
Key Benefits
Maintains QSBS 5-year holding requirement. If your company is sold early, you can roll over your gains into a new QSBS and keep the clock ticking.
Defers capital gains tax. Your capital gains are rolled into the new QSBS, deferring the tax until you sell the new QSBS.
Key Considerations/Flags
Strict requirements around QSBS. The IRS has specific requirements around what qualifies as QSBS. This includes the holding period, the original purchase, and the nature of the company's trade or business. Both the original investment and the new investment need to meet all of the QSBS criteria (excepting the 5-year holding period, which needs to be met in aggregate).
Your initial position must have been held for at least 6 months. You must have held your initial QSBS qualifying investment for at least 6 months prior to a 1045 exchange.
Your new QSBS position must maintain QSBS eligibility for at least 6 months. The new company you invest in must remain eligible for QSBS status for 6 months after you invest in order for your position to qualify for QSBS.
Strategy: When to Consider This and When to Avoid It
🟢 When to Consider This Strategy:
You held qualifying QSBS shares for at least 6 months, but sold before the 5-year holding period.
You want to maintain the tax benefits of QSBS by reinvesting gains into new QSBS.
You have identified a new potential QSBS investment that meets the requirements.
You are able to complete the exchange within 60 days of the sale of your original QSBS shares.
You are comfortable with the investment risk of reinvesting into a QSBS eligible stock (versus keeping the cash from the sale and paying the associated tax).
🔴 When to Not Use This Strategy:
You need liquidity from the sale proceeds of your initial investment,
The original shares you sold did not meet the requirements to qualify for QSBS treatment.
You are unable to identify a new QSBS investment opportunity within 60 days of sale.
You are not comfortable with the investment risk of reinvesting into a new QSBS position
Example
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