Will My Rollover into a PE Holding Company Qualify for QSBS?

Someone on Reddit is selling their company to a private equity holding company (a C Corp) and rolling over some equity; they will own about 13 to 15% of the holding company, which owns and operates plumbing companies. They want to know: If I hold these shares for 5 years, would I qualify for the QSBS exclusion? and How does that impact long-term capital gains tax? The Qualified Small Business Stock (QSBS) exclusion under IRC § 1202 lets you exclude 50%, 75%, or 100% of gain from the sale of qualified stock held more than 5 years (federal). Qualification depends on C Corp, gross assets ≤ $50 million at issuance, 80% active qualified business, how you got the stock (original issuance or qualifying exchange), and holding > 5 years. Rollover stock in a PE holding company may qualify but is not automatic; the $50 million gross-assets test and holding company structure often disqualify PE rollover stock. Consult a tax advisor (M&A / § 1202) for your specific deal.

Bottom line: QSBS = federal exclusion for gain on qualified small business stock held more than 5 years (50%, 75%, or 100% depending on acquisition date; per-issuer limits apply). Qualification requires: C Corp issuer, gross assets not over $50 million before and immediately after issuance, 80% of assets in active qualified trade or business, stock acquired at original issuance or in a qualifying tax-free exchange (rollover can sometimes preserve or tack), and holding > 5 years. Your situation: Rollover into a PE holding company (plumbing) is possible but not guaranteed. PE holding companies often exceed the $50 million gross-assets test after acquisitions, so new stock received in a rollover frequently does not qualify. Plumbing can be a qualified business; the holding company structure and 80% test must be analyzed. Get the deal structure and numbers (gross assets at issuance, how you receive the stock). Consult a tax advisor (ideally M&A / § 1202) to confirm whether your holding company stock can be QSBS, the start of your 5-year holding period, and gain/exclusion when you sell. Margen can help you model gain and tax with and without the QSBS exclusion.

Question from Reddit

Will this qualify for the QSBS exclusion?

Can someone explain the QSBS exclusion to me and let me know if I will qualify?

I am selling my company to a private equity Holding Company (C Corp). I am rolling some equity and will own ~13-15% of the Holding Company.

The Holding Company owns and operates plumbing companies.

If I hold these shares for 5 years. Would I qualify for the QSBS exclusion? How does that impact long term capital gains tax?

Source: Reddit

Analysis

The user is rolling equity into stock of a PE holding company (C Corp) that owns and operates plumbing companies. They want to know whether that stock can qualify as QSBS so that after 5 years they can claim the QSBS exclusion on gain when they sell, and how that affects long-term capital gains tax. QSBS is governed by IRC § 1202 and has strict requirements: type of corporation, gross assets, active business, how and when you acquired the stock, and holding period. Whether rollover stock in a holding company qualifies depends on original issuance vs. rollover/reorganization rules, the holding company's gross assets and active business, and qualified trade or business (plumbing is generally not an excluded service business, but the holding company structure and 80% test matter).

Answer

What is the QSBS exclusion?

IRC § 1202 allows a federal income tax exclusion for gain from the sale of qualified small business stock (QSBS) held for more than 5 years. Depending on when you acquired the stock, you can exclude 50%, 75%, or 100% of that gain from federal income tax (and the rest may be taxed at a preferential rate). So long-term capital gains tax on the sale can be greatly reduced or eliminated if the stock is QSBS and you hold more than 5 years.

How does it impact long-term capital gains tax?

If your holding company stock qualifies as QSBS and you hold it more than 5 years, you may exclude a large portion (or all) of the gain from the sale from federal income. So instead of paying regular long-term capital gains tax (e.g., 0%, 15%, or 20% on the gain), you exclude that gain (up to the applicable percentage and limits). There are per-issuer limits (e.g., the greater of $10 million or 10× your basis in the stock). State tax may still apply; many states do not follow the federal QSBS exclusion.

What has to be true for stock to be QSBS?

The stock must be qualified small business stock under IRC § 1202. Main requirements include:
1. Issuer: A domestic C corporation (your holding company is a C Corp, so that can be satisfied).
2. Acquisition: You generally must have acquired the stock at original issuance from the corporation (for money, property, or services), or in certain tax-free exchanges (e.g., reorganizations) that preserve QSBS under the code and regs. Rolling your existing company into the holding company in a reorganization or exchange can sometimes preserve or tack QSBS holding period or qualify the new stock if the exchange meets specific rules; this is fact-heavy and you need a tax advisor to apply it to your deal.
3. Gross assets: The corporation's aggregate gross assets must not have exceeded $50 million at all times before the stock issuance and immediately after. For a PE holding company that has just acquired your company (and possibly others), the combined gross assets of the holding company (and sometimes subsidiaries) can exceed $50 million. In that case, new stock issued in the rollover might not be QSBS because the $50 million test is failed at or after issuance.
4. Active business: At least 80% (by value) of the corporation's assets must be used in the active conduct of one or more qualified trades or businesses. A holding company that owns operating subsidiaries (e.g., plumbing companies) can sometimes meet this if the subsidiaries' assets and activities are attributed correctly and the businesses are qualified. Plumbing is generally not in the excluded list (e.g., health, law, financial services, brokerage, hospitality), so the type of business (plumbing) can be qualified, but the structure (holding company + subsidiaries) and 80% test must be analyzed.
5. Holding period: You must hold the stock for more than 5 years from the date you acquire it (with tacking in certain tax-free exchanges). So your 5-year clock starts when you receive the holding company stock in the rollover (or when the exchange rules say it started).

Will you qualify?

Maybe, but it's not automatic. It depends on:
- How you get the holding company stock (original issuance in the deal vs. exchange of old stock; whether the exchange preserves QSBS or qualifies the new stock).
- The holding company's gross assets before and immediately after the issuance (or exchange); if they're over $50 million, the stock issued then typically won't be QSBS.
- Whether 80% of the holding company's assets are in active qualified trades or businesses (plumbing can qualify; the holding company structure and attribution need to be checked).
- Holding the stock more than 5 years from the correct acquisition date.
Private equity holding companies often exceed the $50 million gross-assets test after acquisitions, so new stock received in a rollover frequently does not qualify as QSBS. You need a tax professional to look at your specific deal (structure, gross assets at issuance, active business, and rollover terms) to say whether your holding company stock can be QSBS.

What you should do

Get the deal structure and numbers (e.g., gross assets of the holding company before and after your rollover, how you're receiving the stock: original issuance vs. exchange).
Consult a tax advisor (ideally one who does M&A and § 1202) to (1) confirm whether the holding company stock can be QSBS, (2) confirm the start of your 5-year holding period, and (3) plan for gain and exclusion when you sell.
Keep records of your acquisition (date, amount, basis) and of the company's compliance with QSBS requirements (e.g., gross assets, active business) so you can support the exclusion when you sell.
Margen can help you model gain and tax on a future sale with and without the QSBS exclusion so you see the impact.

Applicable Sections

Federal / IRS

IRC § 1202: Partial exclusion for gain from qualified small business stock; defines qualified small business stock and the exclusion (50%, 75%, or 100% depending on acquisition date); holding period more than 5 years; per-issuer limit (e.g., greater of $10 million or 10× basis). (IRS Topic: Qualified Small Business Stock)
Gross assets: Must not exceed $50 million before and immediately after issuance (IRC § 1202(d)(1)).
Active business: At least 80% of assets used in active conduct of a qualified trade or business (IRC § 1202(e)); certain trades (e.g., services in health, law, financial services, brokerage, hospitality) are excluded.
Original issuance / rollover: Stock generally acquired at original issuance or in a qualifying tax-free exchange; regulations and reorganization rules affect rollovers and tacking of holding period.

State

Many states do not conform to the federal QSBS exclusion; state income tax may apply to the full gain. A state tax advisor can confirm.

Practical Notes

QSBS = potential exclusion of 50% to 100% of gain on sale of qualified stock held > 5 years (federal).
Qualification depends on C Corp, gross assets ≤ $50M, 80% active qualified business, how you got the stock (original issuance or qualifying exchange), and holding > 5 years.
Your situation: Rollover into PE holding company (plumbing) is possible but not guaranteed; $50M test and holding company structure often disqualify PE rollover stock; consult a tax pro.
Impact on LTCG: If it qualifies, you exclude a large portion (or all) of the gain from federal tax; state may still tax.
Margen can help you model gain and tax with and without QSBS.
Consult a tax professional (M&A / § 1202) for your exact deal and holding company.

Limitations

This answer does not cover all QSBS rules (e.g., carryover basis, AMT preference, different exclusion % by acquisition date) or state QSBS. It is not tax or legal advice. For your rollover, holding company, and 5-year hold, consult a tax advisor. Margen can help you model the tax on a future sale with and without the exclusion.

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Will My Rollover into a PE Holding Company Qualify for QSBS? (Reddit Q&A)