What is a QSBS Rollover?

Qualified Small Business Stock, or QSBS, under Section 1202 of the Internal Revenue Code, allows investors in certain startups to avoid federal capital gains tax if they hold their shares for at least five years. The rule exempts up to ten million dollars in gains, or ten times the original investment basis, from federal tax.

Founders and early investors who sell before the five year mark risk losing that benefit. The same applies to those whose gains exceed the ten million dollar cap. In both cases the tax bill can reach more than thirty percent of the gain, depending on the taxpayer’s state. Section 1045 of the code, referred to as the QSBS rollover, provides a way to defer taxes and preserve eligibility even in these scenarios.

The rollover works by requiring investors who sell QSBS to reinvest their proceeds into new QSBS stock within sixty days. The gain is deferred rather than recognized and the original holding period carries over to the new stock. If the combined holding period reaches five years the shareholder can claim the full exclusion. For example, a shareholder selling after three years with an eight million dollar gain can reinvest the proceeds into new QSBS. If the new investment is held for two more years, the entire eight million dollars may qualify for exclusionQSBS Rollover Whitepaper.

Rollovers also address situations where gains exceed the ten million dollar cap. Because the limit applies per issuer, gains can be spread across multiple new corporations. A founder selling for forty million dollars could exclude the first ten million under the original stock and roll the remaining thirty million into three new entities, each carrying its own ten million dollar limitQSBS Rollover Whitepaper.

The provision is rarely used because it is difficult to execute. Investors have only sixty days to reinvest and most available options are risky. Angel investments are highly speculative and illiquid. Venture funds typically require commitments of a decade or longer. Starting a new company requires deploying at least eighty percent of capital into operations, which can be unrealistic for individualsQSBS Rollover Whitepaper.

Advisory firms and asset managers are now designing structured rollover vehicles that aim to solve these problems. Some use short term retail and trading businesses to provide predictable liquidity and a clear path to QSBS eligibility. These programs are designed to give shareholders a compliant way to defer tax and later exclude gains that would otherwise be taxableQSBS Rollover MemoDLA QSBS Slides.

The QSBS rollover is ultimately a bridge. It allows investors to push taxes into the future, extend the holding period to meet the five year rule, and in some cases multiply the amount of gain that qualifies for exclusion. While the rules remain complex, structured approaches are making the provision more practical for founders and early shareholders who would otherwise face immediate and substantial tax bills.