Tax Year Prior to 2020: I am eligible for a section 1202 exclusion. How do I indicate that?

[pgormley]

Section 1202 has nothing to do with home sales. This is for sale of stock in a small business. I should be sheltered from a significant portion of my capital gains

[Kadian]

My sincere apologies, I inadvertently place the answer to the wrong question here.. let me go ahead and edit that.. so sorry about that mistake.

[pgormley]

No worries. Can someone answer my question?

[MichaelDC]

Here's how to enter a Qualified small business stock exclusion (Section 1202):

Although the below steps involve editing an existing stock sale entry, you may do well to delete the sale and start fresh.

1. With your return open, search for 1099-B (upper- or lower case, with or without the dash) in your program's search box.
2. Click the Jump to 1099-B link in the search results.
3. On the Did you sell any investments? screen, answer Yes.
4. If you land on the Summary of All Accounts screen instead, click Edit 
5. “If you have additional info about this sale, you can enter it on your own, or we can guide you.”, Select Guide me step-by-step (See the attached screenshot below. Click to enlarge.)
6. Click My sale involves one of these uncommon situations. (See the attached screenshot below. Click to enlarge.)
7. On Choose the type of investment you sold, choose "Stock" (See the attached screenshot below. Click to enlarge.)
8. Review Some Basic Info About this Sale, Click Continue
9. Click through several screens
10. On "Do Any Special Situations Apply to This Sale?", select "Small business stock" click Continue  (See the attached screenshot below. Click to enlarge.)
11. On "What Kind of Small Business Stock?" select the appropriate section 1202 type, click Continue
    Continue through the interview

If you qualify, you'll see a “Net adjustments to gain.” (See the attached screenshot below. Click to enlarge.)

Specialized Small Business Investment Company (SSBIC)

If you invest the proceeds from the sale of publicly traded securities in an SSBIC, you may be able to roll over, or postpone, the gain on your securities sale, if you qualify.

Qualified small business stock

When you sell qualified small business stock for a gain, you may be able to postpone paying income tax on the sale if you used the proceeds to purchase other qualified small business stock under section 1045.

If you did not buy other qualified stock, you may qualify to treat 50%, 60%, 75% or 100% of the gain as tax-free under section 1202 if you held the stock longer than five years.

Section 1244 Stock

Losses on sales of section 1244 stock qualify for special treatment when sold. Instead of a capital loss, section 1244 losses are considered ordinary losses and can reduce your taxable income up to $50,000, or up to $100,000 if you're married filing jointly. (No more than $3,000 of net capital losses can be used to reduce other income each year.

[joules314]

Which TurboTax CD/Download product supports this? (Deluxe? Premier?)

[Lizzi]

Hi pgormley, 

Are you going to claim QSBS exemption? What documents are needed to prove the stock is QSBS?

Thanks!

[wideglidejrp]

My question is about relationship between the 1202 exclusion and line 9a of the K-1. My K-1 shows the details of the 1202 qualifying sales and the amount which can be excluded. I understand how to enter the sale, answer the questions, and see the exclusion. How does the exclusion get reflected on line 9a of the K-1? 

[DaveF1006]

According to this Turbo Tax link, here is the best method for entering this information. Rather than entering the proceeds of the sale of qualified small business stock on line 9a of your K-1, enter the figure under stock sales in order to indicate that the sale was "qualified small business stock."  [It's not going to matter that the entry is not on the K-1.]  Please follow these steps:

1. Click on Federal Taxes > Wages & Income> I'll choose what I work on
2. In the Investment Income section click on the Start/Revisit box next to Stocks, Mutual Funds, Bonds, Other. 
3. If you have already entered some investment sales, you will see a screen Here's the investment sales info we have so far.  Click on the Add More Sales link.  
4. If you haven't yet entered some investment sales, you will see a screen Did you sell any investments in 2019?  Click the Yes box.
5. Answer No to the question, Did you get a 1099-B...?
6. On the screen, Choose the type of investment you sold, mark the button for Stocks and click Continue.  
7. You will be asked questions about the date of sale and purchase and the cost and sales price.  If you don't have the exact information, you can just make entries so that the information results in the figure on line 9a of your K-1 [the net gain; long-term sale, etc.]
8. When you come to the screen, Do Any Special Situations Apply to This Sale? mark the button next to Small business stock and click Continue. 
9. You won't see the amount listed in box 9A of the K1 if you report this according to the steps above. As I mentioned above, it doesn't matter if you report this on a K1 or not as long as you report this information in your return.

[wideglidejrp]

I am confused about the link between line 9a on the K-1 and entries made which qualify for 1202 exclusions. For example, if the K-1 shows 9a=$1,000, but in the notes of the K-1, it shows some sales which qualify for 1202. Following the steps you outlined, may result in a different total long term gain. Do you have to manually compute the amount and enter it on 9a? The partnership who submitted the K-1 may have had gains or losses in companies other than those which are listed as 1202 qualified. 

[ThomasM125]

If some of the amount reported on line 9(a) is section 1202 stock and some is not, you need to determine what the total section 1202 stock gain or loss is, and then make  a separate schedule K-1 entry reporting that amount. So, make the K-1 entry reporting everything listed on it, but with the non-section 1202 gain or loss amount in box 9(a). Then do the same entry again, without duplicating any tax related amounts, but just report the section 1202 total gain or loss in box 9(a). 

And, of course, indicate on the section 1202 entry that it is section 1202 stock.

[wideglidejrp]

Thanks very much for responding to my question. Why not adjust amount on line 9a to reflect the gain/loss after adjusting for the 1202 exclusions? If I make a duplicate K-1, duplicate except for line 9a, then I would double the effect of other lines on the K-1, such as line 1 Ordinary Income, line 5 Interest income, etc. Seems like a thorny problem. The partnerships won't adjust line 9a because they don't want to take a tax advice position on whether the 1202 exclusions qualify even though the companies reported the 1202 exclusions. I would appreciate your further comments on this. Thanks again.

[wideglidejrp]

After reading your reply a couple more times, I understand what you are saying. However, I still have one remaining question. The sum of the two line 9a entries on the two K-1s will not equal what was reported to the IRS on the original K-1. Would that throw up a red flag?

[ThomasM125]

I believe what you are saying is that the gain reflected on line 9(a) of your K-1 schedule is not all taxable, since some of it is excluded under section 1202. So, if you don't report the taxable amount on line 9(a), the IRS might assume you under reported your capital gain income.

The IRS does not allow for an entry on a form to reconcile the gain reported on the schedule K-1 and the taxable amount to report on your tax return. One would assume then that it is not unusual for the two to not agree, so it should not pose a problem. 

This is similar to a situation where the cost basis on a form 1099-B (investment sales) is often not the actual amount of cost basis, so you have to adjust the amount on your tax return. This does not create a problem with the IRS since they are accustomed to the amounts not agreeing, and the forms do not allow for an explanation as to why.

[wideglidejrp]

Thank you very much for the reply. What I understand from your reply is use the correct information and don't worry that the K-1 line 9a amount after adjusting for 1202 effect will not agree with what was entered by the partnership issuing the K-1. I have two additional comments:

1. Seems like there should be a 1202 form which reconciles the K-1 and the Schedule D differences. It cannot be done on the K-1 itself because the partnerships will not take a tax position on the validity of a 1202 adjustment even though the underlying company claims the adjustment to be valid. If 1202 is going to stay, seems to me there should be a better way to handle the reporting. I did it all in a spreadsheet to make sure my numbers are  accurate.

2. Another reply to the original problem suggested the solution is to make a second K-1. However, seems to me that could itself throw up a red flag. For example, if there is stock 100% excluded by 1202, then the second K-1 would be blank. The gain showed would be zero and the other tax related lines, 1, 5, 7, etc. would be blank so as not to duplicate.