Deferring gain on qualified small business stock
Revenue and Taxation Code Section 18038.5 allows a taxpayer to defer recognition of gain from the sale of qualified small business stock (QSBS) under some circumstances. One requirement is the taxpayer must replace the QSBS within 60 days of the sale of the relinquished stock. FTB's position has been that a taxpayer may not use a partnership other than the one selling the QSBS to acquire the replacement stock. If the partnership sold the QSBS stock, the same partnership must purchase the replacement stock. Also, an individual may not use a partnership to acquire replacement stock on his behalf. This position was based on IRS Proposed Regulations (Reg.150562-03).
The IRS issued a final regulation, Reg. 1.1045-1 on August 14, 2007, clarifying some issues regarding partnerships and qualified small business stock. The regulation allows a partnership to acquire qualified small business stock on behalf of its partners, thereby allowing the partners to defer any gains they may have realized on sales of qualified small business stock. The partnership must acquire the replacement stock within 60 days of the partnership's sale of the relinquished stock. All of the other requirements for the stock to be treated as qualified small business stock also apply. The regulation also provides guidance for determining a partner's basis in the partnership that acquires the replacement stock.
This regulation took effect August 14, 2007, and applies for all QSBS transactions occurring on or after August 14.
For transactions prior to August 14, the previous guidance, based on the IRS Proposed Regulation, will be followed: A taxpayer may not use a partnership other than the one selling qualified small business stock to acquire replacement stock. Also, a taxpayer may not use a partnership to acquire replacement stock on his behalf if he sells QSBS as an individual.
Can the partner rollover gain from stock sold by Partnership A using Partnership B as a vehicle to purchase the replacement stock?
The examples below illustrate the treatment for transactions both before and after August 14:
- Partner joined Partnership A on 6/1/X1.
- Partnership A purchases qualified small business stock on 6/2/X1.
- Partnership A sells on 12/3/X2 (six-month holding period is met).
- Partnership A distributes proceeds to partner.
- Partner A is a partner in another partnership (Partnership B) when it purchases qualified small business stock on 12/4/X2 (within 60 days).
- Stock sale before August 14:
No. R&TC Section 18038.5(a)(1) requires that "the" taxpayer purchase the replacement qualified small business stock. Allowing a separate entity (Partnership B) to defer the gain on behalf of Partnership A or the partner is not discussed in the law, or legislative history. Partnership B is a separate entity from its partners for tax purposes.
- Stock sale on or after August 14:
Yes. Per IRS Regulation, this transaction would qualify for gain deferral. The regulation also allows the transaction if the partner sold the stock as an individual, without Partnership A, and used Partnership B to acquire the replacement stock.
However, if Partnership A purchased the replacement stock, the gain could be deferred.This treatment is supported by IRS Proposed Regulations (REG-150562-03) on the application of IRC Section 1045 to partnerships and their partners.