Anyone with experience on Section 1202?

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August 24, 2021

by a searcher from University of Pennsylvania - The Wharton School in Miami, FL, USA

I am working on an asset purchase deal and need to decide whether to form the new entity as an S Corp or as a C Corp for the purpose of taking advantage of the Section 1202 capital gains exemption down the road when we exit (https://rsmus.com/what-we-do/services/tax/federal-tax/corporate-tax-services/understanding-the-qualified-small-business-stock-gain-exclusion.html).

Interested to hear from any buyers who have been through this decision process and how you landed where you did. Also interested to hear from any lawyers/accountants who could share thoughts on the tradeoffs and potentially advise me on the decision.

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Reply by a searcher
from University of Virginia in Los Angeles, CA, USA
^redacted‌, my partner and I are in the process of closing a deal that's structured as an asset purchase where we are incorporating as a C-Corp to take advantage of 1202 tax exemption. You certainly want to work with (i) a knowledgeable accounting firm and (ii) an experienced tax lawyer to ensure the business qualifies for QSBS and that you yourself are establishing the necessary cost-basis that allows you to eventually exclude the max of $10M or 10x cost basis upon exit.

Two key considerations prior to making your decision: 1) are you planning on holding for more than 5 years, or are you looking to do a quicker 3-4 year flip? 2) are the returns predominately driven by proceeds upon exit, or via dividends throughout the holding period? Another important piece to think through is tax rates, and the potential of corporate and/or capital gains taxes going up... right now we believe that in either way, if you have a longer-term, growth-oriented investment where most of the gains will be realized upon exit, C-Corp is the way to go (not to say you can't also drive returns via dividends with a C-Corp). Some may push back and ask, "well doesn't PE not like to buy C-Corps so you're limiting your buyer universe?", or "well what about QBI deductions that you can only use in an LLC?", or "well don't you want the ability to pay dividends?" All of which there are answers to, but that'll take a longer post.
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Reply by a professional
from New York University in New York, NY, USA
Don't be an S Corp. Either be an LLC taxed as a partnership (or a disregarded entity if only one owner) or a C Corp. If you're taking in outside investors you may need to be a C Corp. If you plan on exiting within 5 years, 1202 is inapplicable, plus 1202 only applies to certain industries###-###-#### c)(3) if my memory serves me correctly). Also, if you end up selling the assets (i.e., what you're doing now), you REALLY won't want to be a C Corp). Happy to discuss if you'd like redacted
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