IRS Explains Election to Defer Gain on Sale of QSB Stock.

• Author: Fiore, Nicholas J.

Sec. 1045(a) generally allows a taxpayer other than a C corporation to elect not to recognize gain from the sale of qualified small business (QSB) stock held by the taxpayer for more than six months. If the taxpayer makes the election, gain from such sale is recognized only to the extent that the amount realized on the sale exceeds:

(1) The cost of any QSB stock that the taxpayer purchases during the 60-day period beginning on the date of sale, reduced by

(2) Any portion of the cost of the replacement QSB stock that was previously taken into account under Sec. 1045. However, the election is not available to defer any gain on the sale that is treated as ordinary income for purposes of the Code.

Under Sec. 1045(b), "qualified small business stock" has the same meaning as provided in Sec. 1202(c). Sec. 1045(b)(5) provides that, for QSB stock held through passthrough entities, rules similar to the rules of Sec. 1202(g) apply for Sec. 1045 purposes. For example, a passthrough entity may make a Sec. 1045 election if the entity sells QSB stock held for more than six months and purchases replacement QSB stock during the 60-day period beginning on the date of the sale. The benefit of deferral with respect to a sale of QSB stock by the passthrough entity will flow through to taxpayers (other than C corporations) that held interests in the entity during the entire period in which the entity held the QSB stock. Also, for example, if a passthrough entity sells QSB stock held for more than six months, an individual who held an interest in the entity during the entire period in which the entity held the QSB stock and who purchases replacement QSB stock during the 60-day period beginning on the date of the sale of the QSB stock may make the Sec. 1045 election with respect to the individual's share of any gain on the sale that the entity does not defer under Sec. 1045.

Procedure

Time for making the election. A Sec. 1045 election must be made on or before the later of Dec. 31, 1998, or the due date (including extentions) for filing the income tax return for the tax year in which the QSB stock is sold.

Manner of making the...