Section 1045: QSBS rollovers

What is a Section 1045 rollover?

Section 1045 of the Internal Revenue Code (IRC) outlines the requirements for QSBS rollovers, which allow taxpayers to defer capital gains taxes upon the sale of their qualified small business stock (QSBS). In order to claim the benefits when you sell your stock, you must satisfy certain rollover requirements.

What qualifies as QSBS?

For QSBS-eligible stock to qualify as QSBS (and receive the tax benefit), it must typically be held for at least five years. If you sell eligible shares before this holding period has been completed, you may be subject to tax liabilities on the sale of those shares. This is where Section 1045 comes in; it allows you to preserve QSBS eligibility through a stock rollover. 

How to preserve QSBS eligibility through Section 1045 rollovers

Section 1045 allows for a rollover of otherwise taxable proceeds into new QSBS (replacement stock). Through a QSBS rollover, you can defer recognition of capital gains and reinvest the proceeds into other QSBS, thus preserving the holding period from your original investment.  

Note: If you’re thinking about electing to report a Section 1045 rollover, we recommend working with a qualified tax professional. If your company uses Carta for equity management, you may have access to an equity tax advisor for free.

Reporting a QSBS rollover

To elect a Section 1045 rollover, taxpayers must complete Form 8949 and Schedule D (Form 1040) as part of their income tax return. The gain should be reported on Form 8949 under either Part I or Part II, depending on how long the QSBS was held by the partnership.

When reporting the gain, taxpayers treat it as any other short- or long-term capital gain but must enter “R” in column (f) of Form 8949. The amount of non-recognized gain is then noted in parentheses in column (g).

Additionally, taxpayers need to attach a statement to Schedule D (Form 1040) that provides the following details:

• The name of the corporation that issued the QSB stock

• The name and employer identification number (EIN) of the selling partnership

• The dates the QSB stock was purchased and sold

• The amount of gain that isn’t recognized under Section 1045

• The name of the corporation that issued the replacement QSB stock

• The date the replacement stock was purchased

• The cost of the replacement stock

Section 1045 rollover when a partnership purchases replacement stock

Under Section 1045, if a partnership purchases replacement QSBS within 60 days of the sale, the gain can be deferred at the partnership level. The partners can then benefit from the rollover deferral as long as the partnership itself meets the requirements for §1045 and reinvests in qualified stock.

Reporting the gain

If a partnership elects to rollover the gain into new QSBS, the gain eligible for Section 1045 rollover treatment should be reported on Schedule K-1, line 11, code M of the partner’s Schedule K-1. 

The partnership should also provide taxpayers with the following information:

1. The name of the corporation that issued the QSBS

2. The recipient’s share of the partnership’s adjusted basis and sales price of the QSBS

3. The dates the QSBS was bought and sold

4. The recipient’s share of gain from the sale of the QSBS

5. Your share of the gain that was deferred by the partnership under Section 1045

Section 1045 rollover when a partnership does not purchase replacement stock

If a partnership does not purchase replacement stock, the partners can still elect to defer their individual share of the gain, as long as the replacement stock is purchased in their own name.

Step one: Reporting the gain

The gain eligible for Section 1045 rollover treatment should be reported on Schedule K-1, line 11, code N of the partner’s Schedule K-1. The partnership should provide taxpayers with the following:

1. The name of the corporation that issued the QSBS

2. The recipient’s share of the partnership’s adjusted basis and sales price of the QSBS

3. The dates the QSBS was bought and sold

4. The recipient’s share of gain from the sale of the QSBS

Step two: Rollover election

See “Reporting a QSBS Rollover” section above.

Opting in or opting out

A partner also has a decision to make as to whether they want to opt in with their partnership’s election to rollover QSBS gains, opt out of the election, or opt out and rollover gain into QSBS of their choosing . 

Opt in with their partnership’s election to rollover QSBS gains

To opt in, follow the instructions outlined under the “Reporting a QSBS rollover” section below.

Opt out of the election

To opt out, the partner must report the gain as any other on Form 8949 and notify the partnership in writing of the amount of gain they are recognizing. 

Opt out and rollover gain into a QSBS

Instructions for reporting this are also listed under the “Reporting a QSBS rollover” section below. Again, the partner should disclose their decision to opt out, in writing, to the partnership.