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Ext. PublicationRevamped QSBS Rules Offer Major Opportunities for Investment Funds under the One Big Beautiful Bill Act
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The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, made substantial and investor-friendly changes to Internal Revenue Code (IRC) Section 1202, which governs qualified small business stock (QSBS). These updates are highly relevant to investment fund managers, specifically those focused on venture capital, growth equity and early-stage private investments, as they broaden both the scope and flexibility of QSBS planning.
What’s Changed: Key QSBS Updates Under the OBBBA
The OBBBA brings meaningful updates to QSBS rules that affect how funds approach investment timing and tax planning. Three changes introduce more flexibility, higher thresholds and a broader range of eligible companies.
1. Tiered gain exclusion: New holding periods
Previously, the full 100% federal capital gain exclusion required a five-year holding period. This rigid structure often deterred funds from timing exits optimally or accommodating liquidity preferences of limited partners (LPs).
The OBBBA replaces the all-or-nothing model with a tiered schedule:
- 50% exclusion after three years
- 75% exclusion after four years
- 100% exclusion after five years
This tiered approach introduces exit flexibility without forfeiting the QSBS benefit entirely. Fund managers can now structure distributions or secondary sales earlier in a company’s lifecycle while preserving meaningful tax efficiency.
2. Expanded gain exclusion cap
The exclusion cap per taxpayer was increased from the greater of $10 million or 10× basis to the greater of $15 million or 10 times basis. Beginning in 2027, this exclusion limit will be indexed for inflation.
For investors deploying larger capital checks, this enhancement improves the economics of investing in eligible C corporations.
3. Higher eligibility threshold for issuers
To qualify for QSBS treatment, the issuing corporation must have gross assets under a defined threshold at the time of stock issuance. The OBBBA raises this threshold from $50 million to $75 million and will be indexed for inflation starting in 2027.
This change expands QSBS eligibility to later stage companies, capital intensive startups (e.g., in clean energy or biotech) and certain pre-initial public offering (IPO) tech companies. As a result, fund managers have a broader investable universe for QSBS-qualified stock without having to restrict themselves only to very early stage businesses.
Effective Date and Transition Planning
All changes apply only to stock issued on or after July 5, 2025. Preexisting QSBS is not grandfathered into the new rules. This puts pressure on funds to carefully document issuance dates and segregate pre- and post-OBBBA investments.
Implications for Fund Structuring and Tax Planning
These updates offer strategic tax advantages for general partners (GPs) and LPs alike:
- Earlier liquidity with partial tax relief available after only three years
- Enhanced flexibility for founders and investors in structuring time sensitive exits
- Broader eligibility enabling larger companies to participate
Caveat: Because QSBS benefits apply at the partner level, fund managers must ensure that entity structuring, basis tracking and holding period (allocating pre- vs. post OBBBA tranches) records are meticulously maintained.
Key Takeaways
The OBBBA’s updates to IRC Section 1202 significantly elevate QSBS as a powerful tax planning tool in fund strategy. With more companies eligible, a phased benefit structure and a higher cap on tax-free gains, fund managers now have a compelling incentive to reevaluate portfolio construction, holding periods and exit timing with QSBS optimization in mind.
Expanded QSBS rules under the OBBBA create new advantages for investment funds. However, capturing the full benefit requires careful planning, proactive strategy and precise execution. We’re here to help. Contact us to stay ahead of the changes and build lasting value.
©2025
