Why You Should Consider Investing in Qualified Small Business Stock

Why You Should Consider Investing in Qualified Small Business Stock

If you’re looking for a high-risk, high-reward investment opportunity with a potential for significant tax benefits, investing in Qualified Small Business Stock (QSBS) may be something you should consider. QSBS is a unique investment type that has been gaining traction in recent years, and for good reason.

In this article, we’ll take a closer look at what QSBS is, how it works, and the potential benefits of investing in it.

What is Qualified Small Business Stock?

Qualified Small Business Stock, as the name suggests, refers to shares of stock in a small business that meets certain criteria set forth by the Internal Revenue Service (IRS). Specifically, the business must have gross assets no greater than $50 million at the time the stock is issued and immediately after the issuance. Additionally, at least 80% of its assets must be used in the active conduct of one or more qualified businesses.

If a stock meets these requirements, it can be classified as QSBS. Investors who purchase QSBS and hold it for a certain period of time may be eligible for significant tax benefits, including an exclusion of up to 100% of the gain realized on the investment.

How Does QSBS Work?

To be eligible for the QSBS tax benefits, you must hold the investment for at least five years. If you meet this requirement, you may be able to exclude up to 100% of the gain realized on the sale of the investment.

To put this in perspective, consider an investor who purchases $100,000 worth of QSBS. After holding the investment for at least five years, they sell it for $400,000. If they meet all the requirements for the QSBS tax exclusion, they may be able to exclude up to $300,000 of the gain from their taxable income.

What are the Benefits of Investing in QSBS?

One of the primary benefits of investing in QSBS is the potential for significant tax savings. As we just discussed, investors who meet the requirements for the QSBS tax exclusion may be able to exclude up to 100% of the gain realized on the investment from their taxable income. This can be a substantial benefit, particularly for high-income investors.

Additionally, investing in QSBS can provide an opportunity to invest in high-growth small businesses that may be too risky for traditional equity investments. Small businesses often have the potential for high returns, but they are also more likely to fail than larger, more established companies. Investing in QSBS allows you to take advantage of the potential upside of these investments while also minimizing your risk through the potential tax benefits.

Examples of Successful QSBS Investments

While QSBS is a relatively new investment type, there have already been many successful investments in this area. One notable example is Brian Sharples, the founder of HomeAway. Sharples invested in QSBS in the early stages of his company’s development and was able to take advantage of the QSBS tax exclusion when he sold his shares after the company went public.

Another example is Doug Burgum, the founder of Great Plains Software, who invested in QSBS in the early stages of his company’s development and was able to sell his shares for a significant gain when Microsoft acquired the company in 2000.

Conclusion

While investing in Qualified Small Business Stock certainly comes with risks, the potential tax benefits and opportunity to invest in high-growth small businesses make it an attractive option for many investors. If you’re looking for a high-risk, high-reward investment opportunity and are willing to hold your investment for at least five years, investing in QSBS may be something you should consider. As always, it’s important to consult with a financial advisor before making any investment decisions to ensure that you fully understand the risks and potential benefits.