Leveraging IRC Section 1045: Rolling Over QSBS Gains Before the Five-Year Mark

Qualified small business stock (QSBS) issued by a C‑corporation can provide founders and investors with powerful tax advantages under IRC §1202. However, not every exit fits neatly within the five‑year holding period required for a full 1202 exclusion, and sales that push investors above the per‑issuer cap may leave additional gains exposed to tax. Fortunately, IRC §1045 offers an alternative: it allows taxpayers to defer capital‑gains tax on the sale of QSBS by reinvesting the proceeds into new QSBS within a short window of time. This article explains how the §1045 rollover works, its requirements and benefits, and why it remains relevant under the 2025 One Big Beautiful Bill Act (OBBBA).

Background and Context

QSBS Basics and Recent Reforms

Under IRC §1202, non‑corporate taxpayers can exclude up to 100 % of the gain from the sale of QSBS if they hold the shares for five years (or three or four years for partial exclusions on stock issued after July 4 2025) and meet other qualifications. The OBBBA expanded §1202 by offering partial exclusions after three and four years and increasing the per‑issuer cap to $15 million while raising the asset threshold to $75 million. These changes make the QSBS regime more attractive but do not help investors who exit before the required holding period or who exceed the exclusion cap.

Enter Section 1045

IRC §1045 was enacted to encourage continued investment in small businesses and provides a way to defer rather than exclude gains. When a taxpayer sells QSBS held for more than six months, the gain may be deferred by rolling the proceeds into replacement QSBS within 60 days. Unlike §1202, §1045 has no dollar cap on the amount of gain deferred. After reinvestment, the holding period of the original QSBS is tacked on to the replacement stock, so investors may still qualify for a future §1202 exclusion if they ultimately meet the five‑year requirement. Importantly, the OBBBA did not change §1045, so this rollover remains fully available in 2025.

How Section 1045 Works

Core Requirements

To make a valid §1045 rollover election, the following conditions must generally be met:

• Original stock must be QSBS. The stock sold must qualify under §1202 at the time of sale.
• Six‑month holding period. The taxpayer must have held the original QSBS for more than six months before selling.
• 60‑day reinvestment window. Proceeds must be reinvested in replacement QSBS within 60 days of the sale; this reinvestment can be into one or multiple issuers. When a partnership sells QSBS, the partnership can reinvest at the entity level or each partner can reinvest their share individually.
• Replacement stock must be new QSBS. The replacement shares must be newly issued in exchange for money (not purchased on a secondary market) and the issuing corporation must be a domestic C‑corporation.
• Active‑business requirement for replacement. The replacement corporation must meet the §1202 active‑business requirement (80 % of assets used in active business) for at least the first six months after the shares are issued; after that, the corporation can engage in other activities without jeopardizing the rollover.
• Election and reporting. A §1045 election must be made on a timely filed tax return, and taxpayers must attach a statement identifying the corporations involved, purchase and sale dates, amount of deferred gain, and cost of replacement stock. For individuals, the gain and deferral are reported on Form 8949 and Schedule D; partnerships report deferred gain on Schedule K‑1 (line 11, code M or N) and provide partners with detailed information to complete their own returns.

Carryover of the Holding Period

An essential feature of §1045 is that the holding period tacks; the time spent holding the original QSBS is added to the holding period of the replacement stock. This allows taxpayers who sold stock after, say, two or four years to meet the five‑year requirement for a full §1202 exclusion when they later sell the replacement QSBS. The rollover thus serves as a bridge between partial OBBBA exclusions (after three or four years) and the traditional five‑year 100 % exclusion.

No Dollar Cap on Deferral

Unlike §1202, which imposes a per‑issuer cap on excluded gain, §1045 permits deferral of any amount of gain, subject to proper reinvestment and election. In fact, an investor can sell original QSBS, claim a $15 million exclusion under §1202 for part of the proceeds, and roll over the excess into replacement QSBS to defer the remainder. Because each replacement investment may itself qualify for a separate §1202 cap, serial use of §1045 can enable large aggregate exclusions over time.

Benefits and Planning Opportunities

• Section 1045 rollovers provide several advantages for founders and early investors:

• Defers tax on early exits. If circumstances (such as M&A or personal liquidity needs) require a sale before the five‑year mark, §1045 allows the seller to defer recognition of gain, preserving cash for reinvestment. This is particularly useful when the OBBBA’s three‑ and four‑year partial exclusions are not sufficient or when the stock is older (pre‑OBBBA) and still subject to the five‑year requirement.

• Bridges to §1202. Because the holding period carries over to the replacement stock, a rollover can help the taxpayer eventually qualify for the full §1202 exclusion on a later sale. By combining §1045 with §1202, one can defer gain today and potentially exclude it altogether in the future.

Unlimited deferral and stacking. There is no dollar limit on deferred gain under § 1045. Investors whose gains exceed the $15 million (inflation-indexed) per-issuer cap can roll over the excess and potentially stack multiple exclusions by investing in several replacement QSBS issuers.

Flexibility in replacement investments. Replacement QSBS can be issued by unrelated startups, or the seller can form a new corporation to issue replacement shares and begin a fresh venture. The 80 % active-business requirement applies only for the first six months after issuance, allowing the new entity to pivot or engage in other activities thereafter.

Pitfalls and Planning Considerations. Despite its advantages, §1045 carries strict requirements and practical challenges:

Replacement QSBS must be genuinely qualified. The replacement corporation must issue stock for cash (not property or services) and meet the active-business test for six months. Simply forming a shell corporation and leaving it idle will disqualify the rollover; the new entity must promptly commence active operations.

Complexity for partnerships and trusts. Partnerships can make the election at the entity level, but partners may have to supply information and decide whether to opt in or out. Trusts and grantor trusts must carefully track the holding period and ensure that the beneficiaries meet the requirements.

Documentation burden. A successful §1045 election requires detailed record‑keeping and a statement attached to the tax return listing the corporations involved, purchase and sale dates, amounts of deferred gain, and cost of replacement stock. Missing any element can jeopardize deferral.

State tax considerations. Some states do not conform to §1202 but may still recognize §1045 deferral or impose their own capital gains taxes. In Washington, for example, the capital‑gains excise tax  follows federal QSBS exclusions but

Example – Selling before five years and deferring gain

Michael founded a C‑corporation on January 1 2024, and the stock he holds qualifies as QSBS. On June 30 2027—after 3.5 years—Michael receives an attractive offer to sell his shares for $5 million. Because he hasn’t met the five‑year holding requirement for a §1202 exclusion, a direct sale would trigger tax on the full $5 million. Instead, Michael sells the stock but reinvests $4 million of the proceeds into replacement QSBS within 60 days. Under §1045, he defers tax on the reinvested $4 million and pays tax only on the $1 million he keeps. The 3.5‑year holding period carries over to the replacement QSBS, positioning him to reach the five‑year mark sooner.

Sarah owns QSBS that she acquired two years ago with no basis. She sells the stock for $500,000 and wishes to defer the entire gain. Within 60 days, Sarah forms a new C‑corporation and invests all $500,000 into the new entity. Because she reinvests 100 % of the proceeds within the 60‑day window and the new corporation meets the active‑business requirement, she defers tax on the full $500,000. Her basis in the replacement stock is $0, and the two‑year holding period tacks onto the replacement stock’s holding period. If Sarah invests only $400,000 and keeps $100,000, she defers tax on $400,000 but recognizes gain on the retained portion.

Example – Forming a new corporation for the rollover

Suppose a founder sold QSBS held for five years and excluded $15 million of gain under §1202 (post‑OBBBA cap). If the total proceeds were $25 million, the remaining $10 million would be taxable. By reinvesting that $10 million into replacement QSBS within 60 days, the founder can defer the excess gain without affecting the original exclusion cap. The replacement stock starts with a five‑year holding period, so any future sale can qualify for another $15 million exclusion under §1202.

Practical Steps for Implementing a §1045 Rollover

Conclusion

Section 1045 offers founders, employees and early investors a valuable tool to defer capital‑gains tax when they sell QSBS before reaching the full §1202 holding period. By reinvesting within 60 days and meeting the statutory requirements, taxpayers can preserve their QSBS benefits and potentially convert deferred gain into a future exclusion. With the OBBBA expanding the QSBS regime but leaving §1045 untouched, careful planning around rollovers is more important than ever. Because of the strict timelines and complex qualification rules, anyone considering a §1045 rollover should engage experienced tax and legal advisors. A well‑executed rollover can unlock significant tax savings and keep capital at work in the vibrant start‑up ecosystem.ay treat deferred gains differently. Consult a local tax advisor to evaluate state‑level consequences.