How to Report 1202 Gain Exclusion From a K-1

Section 1202 of the Internal Revenue Code offers a significant tax incentive for individuals who invest in qualified small businesses. This provision allows for the exclusion of a portion, or even all, of the capital gains realized from the sale of eligible stock. Section 1202 aims to encourage capital investment in domestic small businesses, fostering economic growth. This article outlines the process for reporting Section 1202 gain exclusions, particularly when the underlying gain information is provided on a Schedule K-1.

Qualified Small Business Stock Eligibility

For stock to qualify for Section 1202 benefits, it must meet several strict criteria as Qualified Small Business Stock (QSBS). The issuing entity must be a domestic C corporation; S corporations and partnerships are generally ineligible to issue QSBS. This corporate structure must be in place at the time the stock is issued and remain so during substantially all of the taxpayer’s holding period.

A fundamental requirement is the “original issuance” rule, dictating that the stock must be acquired directly from the issuing corporation. This acquisition must be in exchange for money, property (excluding other stock), or as compensation for services provided to the corporation. Stock purchased from another shareholder in a secondary market transaction typically does not qualify.

The issuing corporation must also satisfy a gross assets test. Its aggregate gross assets, including cash and the adjusted tax basis of other property, must not have exceeded $50 million at any time from August 10, 1993, until immediately after the stock was issued. For stock issued after July 4, 2025, this asset limit has been increased to $75 million.

The corporation must meet an “active business” requirement for substantially all of the taxpayer’s holding period. This means at least 80% of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses. Certain industries are specifically excluded, such as services in health, law, accounting, finance, or hospitality, and businesses primarily involved in real estate, farming, or mining.

Finally, the QSBS must be held for a minimum duration to be eligible for the exclusion. For most stock currently held, this period must be more than five years. For stock issued after July 4, 2025, new legislation introduces a tiered holding period: 50% exclusion for stock held at least three years, 75% for four years, and 100% for five years.

Locating Section 1202 Data on Your K-1

When an investment in a qualified small business is made through a pass-through entity, such as a partnership or S corporation, information relevant to a potential Section 1202 gain exclusion is typically reported on a Schedule K-1. Partnerships issue Form 1065 Schedule K-1 to their partners, and S corporations issue Form 1120-S Schedule K-1 to their shareholders. These documents pass through the entity’s income, deductions, credits, and other items to individual investors for tax reporting.

Information regarding potential Section 1202 gain is often found in Box 11 (Other Income (Loss)) on a Form 1065 Schedule K-1, or a similar “other income” box on an S corporation K-1. This box may contain a specific code, such as “F,” or a general reference indicating supplemental information. The most detailed information is usually presented in a supplemental statement or attachment accompanying the K-1.

The K-1 and its attachments will indicate a potential Section 1202 gain that may be eligible for exclusion. The K-1 itself does not calculate the final exclusion amount. The individual taxpayer remains responsible for verifying that the underlying stock meets all QSBS eligibility requirements and for calculating the precise exclusion amount based on their specific investment details and holding period.

Determining Your Section 1202 Exclusion Amount

Calculating the excludable amount of Section 1202 gain involves applying specific percentages and limitations based on the stock’s acquisition date. For stock acquired before February 18, 2009, 50% of the eligible gain may be excluded. Stock acquired between February 18, 2009, and September 27, 2010, qualifies for a 75% exclusion. For stock acquired after September 27, 2010, the exclusion percentage increases to 100%.

The amount of gain that can be excluded is subject to a per-issuer limitation. This limitation is generally the greater of $10 million or 10 times the aggregate adjusted basis of the QSBS sold by the taxpayer during the taxable year. For example, if a taxpayer invested $1 million in QSBS, they could potentially exclude up to $10 million in gain. This $10 million cap is a lifetime exclusion limit per issuer, reduced by any Section 1202 gain excluded in prior years from stock of the same corporation.

The 10 times adjusted basis rule applies to the basis of the QSBS sold in a given tax year. This means a taxpayer with a high basis in their QSBS might be able to exclude significantly more than $10 million if 10 times their basis exceeds that amount. For stock issued after July 4, 2025, new legislation has increased the $10 million cap to $15 million, while retaining the 10 times adjusted basis alternative.

When multiple sales of QSBS from the same issuer occur across different tax years, the $10 million (or $15 million for newer stock) lifetime cap is applied cumulatively. If the gain from a sale exceeds this cap, the excess gain is fully taxable.

Reporting Your Section 1202 Exclusion

Once the Section 1202 exclusion amount has been calculated, it must be reported on specific tax forms. The primary form for reporting the sale of capital assets, including QSBS, is Form 8949, Sales and Other Dispositions of Capital Assets. On Form 8949, the full gross proceeds and cost basis from the sale of the QSBS, as reported on the K-1, are initially entered.

To claim the Section 1202 exclusion, the taxpayer must adjust the gain directly on Form 8949. This is done by entering code “Q” in column (f) of Part II of Form 8949. In column (g), the amount of the excluded gain is entered as a negative number, effectively reducing the taxable gain.

The adjusted gain or loss from Form 8949 then carries over to Schedule D, Capital Gains and Losses. Schedule D aggregates all capital gains and losses for the tax year. The Section 1202 exclusion reduces the long-term capital gain subject to tax, which is reflected on Schedule D.

A portion of the Section 1202 gain exclusion may also have implications for the Alternative Minimum Tax (AMT). For QSBS qualifying for the 50% exclusion (stock acquired before February 18, 2009), 7% of the excluded gain is treated as an AMT preference item. This amount may be added back for AMT calculation purposes on Form 6251, Alternative Minimum Tax—Individuals. However, for QSBS qualifying for the 75% or 100% exclusion, the excluded gain generally does not create an AMT preference item.