From the March 2001 issue of Entrepreneur

Do you need or want a cash infusion? A little-known provision in the tax code could result in big savings in capital gains taxes if you invest in entrepreneurial ventures.

The provision, Section 1045, became effective under the Taxpayer Relief Act of 1997 to encourage new investment in small business, says Rande Spiegelman, senior manager of personal financial planning for accounting firm KPMG in San Francisco.

Under the provision, you're allowed to roll gains from one small-business investment into another and put off paying taxes owed from the initial investment, the money for which can be from any source. With this type of tax deferral, if you roll over all your gain, you may get 100 cents on the dollar when you reinvest.

To qualify for the deferral, the investments must be considered Qualified Small Business Stock (QSBS). This means the stock has to satisfy all the requirements stipulated in Section 1202 of the law. The business you're investing in must be active and organized as a C corporation; must have been acquired by the taxpayer at its original issue in exchange for money and have assets below $50 million when you make your investment; and its stock must have been originally issued after August 10, 1993. But know there are also some businesses that don't qualify for the special tax treatment, including banks, hotels, restaurants and professional service companies.


Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 14 years.

Finding Companies That Qualify

If your investment meets all the requirements and you've held it for at least six months, you can roll over the gain from your original investment into another QSBS. Remember, though, that once you sell your first investment, you have only 60 days to move your funds into a new one to defer the taxes.

Of course, the new investment must meet the same requirements to qualify for the special tax treatment. The 60-day window is a very limited time frame in which to react, says John Evans, managing director of Venture Investment Management Co. LLC in Boston, so it's best to know before you actually sell your investment where you're planning your next one.

Spiegelman advises you not to let the tax benefits go to your head. The most important consideration is your investment decision. "It's pointless to defer the gain if you go into an investment where you lose all your money,' he warns.

Evans agrees. "Look carefully at the company you are investing in first. That is your prime consideration for making the investment. You need to be confident that it has great potential."

If Section 1045 appeals to you and you're aware of companies likely to meet the requirements, there are no limits on how big the business you decide to invest in can become or how many times you can roll over your gains.

On the flip side, if your business qualifies as QSBS, it could be time to point that out to others seeking investments. It might land you some cash, too.


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