The 1045 Exchange
The 1045 Exchange is the process of exchanging one Qualified Small Business Stock (QSBS) for another QSBS that allows you to defer capital gains. A few blogs ago I wrote about a 1031 exchange which you can read by clicking here. In a 1031 exchange, you are allowed to roll over the gain on the sale of an investment property if you buy a new property within a certain period. While the 1031 exchange deals with real estate, the 1045 exchange deals with QSBS, but they both follow the same principles. The ability to defer gains.
The 1045 exchange takes advantage of Section 1202 which I also did a blog on which can be found here. The basics of 1202 are that it must be a domestic C corporation, the business must never have surpassed the $50 million gross-asset test, and the business must be actively engaged in a product-based business. The stock then must be held for at least 5 years and you must have purchased the stock directly from the company. You are then allowed to exclude up to $10 million or 10 times the adjusted basis of the stock.
Where does 1045 come into play?
The 5-year holding period to qualify for Section 1202 can be a turn-off for some investors. The 1045 exchange allows you to exchange one QSBS for another QSBS. Now, before everyone jumps to call their money person, some criteria must be met first. You must own the QSBS for 6 months first, then you can sell the stock. At that point, you have 60 days to perform the rollover into another QSBS to defer gains. Be careful here because the company that issues that new stock must remain eligible for Qualified Small Business status for 6 months for the new investment to maintain its QSBS status.
Why would you use 1045?
Imagine a scenario where your investment reaches an exit event, meaning the value of the stock has reached a high value, but you just invested 6 months ago and would get destroyed by capital gains. Section 1045 to the rescue, just roll that investment and gains to another QSBS, tack on those previous 6 months of ownership and now you can keep jumping from investment to investment without paying tax on the gains, provided you follow the new rules under Section 1045.
For questions about Section 1045, and to see if you are eligible to perform a 1045 exchange, please reach out to the Center for Financial, Legal, and Tax Planning, Inc., at (618) 997-3436 for more information.