Sure, You’ve Heard of 1031 Exchanges, But What About 1045 Exchanges?

1045 exchangesBy Joe Wallin & Michael Gentile

The Internal Revenue Code contains a number of preferential tax treatment provisions for small businesses. One that is often overlooked is Section 1045, which generally permits a non-corporate taxpayer to elect to defer recognizing gain on the sale of qualified small business (QSB) stock held for more than six months to the extent the proceeds are reinvested in other QSB stock during a 60-day period beginning on the date of the sale.

With certain exceptions, QSB stock means any stock acquired on original issuance by the taxpayer from a domestic C corporation after August 10, 1993 that meets the following requirements: (1) the aggregate gross assets of the corporation must not have exceeded $50 million at the time of and immediately after the issuance of the stock; and (2) at least 80% of the value of the corporation’s assets must have been used in an active trade or business.  IRC Section 1202.

Section 1045 permits founders and angel investors to move money from one business venture to the next without having to pay tax on appreciation in the first business venture.  Because the benefit of Section 1045 applies only to stock in C corporations, it should be taken into consideration by entrepreneurs in choosing the form of their business ventures.
If you form as an S corporation, you will not be able to access the benefits of Section 1202 or Section 1045 with respect to your founders’ stock.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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  • Brett Fogle

    Very interesting.. I had heard of 1031 exchanges in real estate, but have never heard of this before. Good to know!

  • Bloemberg

    Is rental of equipment (where the rental contracts make no provision for title to the equipment ever to pass to lessees) considered a “leasing” activity of the kind that would not qualify as an “active trade or business” (and would therefore disqualify the seller of such stock from deferring gain under Sec. 1045 or from excluding gain under Sec. 1202)?

    • Joe Wallin

      Yeah, so I think this question is not one that is readily answerable on a blog. But I am sure that there are plenty of tax lawyers and tax accountants who would be happy to research this question for you.