Qualified Small Business Stock (QSBS)

As published at https://www.investopedia.com/terms/q/qsbs-qualified-small-business-stock.asp, Fusion Farms is a Qualified Small Business Stock. The Internal Revenue Code (IRC) Section 1202 defines a qualified small business (QSB). This is separate and apart from being a Qualified Opportunity Zone Investment, so this may be of special interest to prospective investors.

What is a Qualified Small Business Stock (QSBS)

A qualified small business stock (QSBS) is the stock, or share, of a qualified small business (QSB), as defined by the Internal Revenue Code (IRC). A qualified small business is a domestic and active C-corporation whose gross assets, valued at original cost, do not exceed $50 million on and immediately after its stock issuance.

Tax Implications for Qualified Small Business Stocks

Tax treatment for a QSB stock depends on when the stock was acquired and the length of its holding. The Protecting Americans from Tax Hikes Act (PATH Act), allows investors to exclude 100% of capital gains on qualified small business stock (QSBS) if the stock qualifies under Section 1202 of the IRC. The exclusion has a cap of $10 million, or 10 times the adjusted basis of the stock, whichever is greater.  Again, this is separate and apart from the benefits an investor might get from Fusion Farms being a Qualified Opportunity Zone Investment.

What is Section 1244 Stock?

Section 1244 of the Internal Revenue Code is the small business stock provision enacted to allow shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than as a capital loss, which is limited to only $3,000 annually.

Normally, stock is treated as a capital asset and if disposed of at a loss, the loss is deducted as a capital loss. The general rule for net capital losses (losses that exceed gains) is that they are subject to an annual deduction limit of only $3,000. Any excess over $3,000 must be carried over to the next year.

A loss on Section 1244 stock, on the other hand, is deductible as an ordinary loss up to $50,000 ($100,000 on a joint return, even if only one spouse has a Section 1244 loss). A big difference!

What this means is that in the unlikely – but possible – scenario that Fusion Farms doesn’t succeed (and create tax-free profits for them upon sale, or greatly reduced taxes as an Act 22 investor), investors can deduct their losses from ordinary income (for mainland investors).

Note that ordinary losses are normally 100% deductible. However, while a loss on Section 1244 stock is treated as an ordinary loss, the deduction is limited to the amounts stated above.