You made a $5,000 investment (in a QSBS C-Corp) through VentureSouth in 2016 and we sent you back $45,000 for the capital gain in 2018. What tax do you owe?
If you’ve followed the last posts, you should have enough information to say “I hoped it would get the Section 1202 exclusion, but because the hold period was less than five years I pay capital gains tax on the gain.”
And with numbers, assuming again you’re in the top bracket and simplifying a little, you pay {$45,000 minus $5,000} * 20% = $8,000.
You could be right, but, like a (very niche) Choose Your Own Adventure book, you should go to Section 1045 of the tax code now.
Section 1045 (primary source here again) basically says that instead of paying gains you can “roll the proceeds over” into new QSBS and therefore defer paying taxes on them. If the total hold period exceeds five years, the Section 1202 exemption applies to all the gains.
To unpack that a little:
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Let’s say I take my $45,000 of proceeds and use it to make another basic angel investment in a QSBS-eligible C-Corp equity.
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As a result, I don’t yet have to pay the capital gain I would owe.
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If I keep holding this new investment for another three years (two years plus three years = five years in total), then I exit again I never pay the capital gains – neither those I owed from the first invest nor any from the second investment.
Pretty good. Back to keeping all my proceeds.
Again, there are naturally some limitations: you have to “roll over” the proceeds (not just the gain); you have only 60 days to find and execute the investments (if only there was somewhere you could go to find a steady supply of eligible investments…); and if you held the first stock for less than six months you can’t do this at all.
But still, for most successful angel deals, 1202 or 1045 should apply, so I think we’re justified in saying that Section 1202 is the Dabo of the tax code.
(By the way, I didn’t make the scenario above up. VentureSouth members faced exactly this calculation when we sent their K-1s in 2019 for the handsome gain they made on a sale in 2018 of a company that was invested in during 2016. Lots of members did the Section 1045 roll over into new VentureSouth investments.)