Qualifying for Section 1202: The IRS Provides Clarity on a Taxpayer’s Eligibility
May 18, 2022
At a glance
- The main takeaway: In a Chief Counsel Memo, the IRS concluded that a taxpayer’s business of facilitating rental property agreements between lessors and lessees should be classified as brokerage services thus deeming them ineligible for Section 1202.
- Impact on your business: For a taxpayer to receive the incentives that come with Section 1202, they must satisfy the complex requirements set forth by the IRS.
- Next steps: Not sure if you’re business qualifies to receive the QSBS tax incentives under Section 1202? Aprio’s Transaction Advisory Team can help you navigate the complexities to determine your eligibility.
Schedule a consultation with an Aprio advisor.
The full story:
It’s not often that taxpayers get excited over a tax provision and Section 1202 gives taxpayers something to rejoice about it. Section 1202 states that taxpayers can exclude up to $10 million in capital gain on the sale of a qualified small business stock (QSBS).
However, to qualify for this tax incentive, a taxpayer must satisfy specific requirements with some tricky gray areas. We dove deeper into Section 1202 and the requirements in a previous article — “What’s All the Talk About a $10 Million Tax-Free Capital Gain?”
In the beginning of the year, the IRS issued Chief Counsel Memo (CCA) 202204007 in response to a taxpayer seeking a better understanding to whether they qualified for the tax incentives. The scenario presented to the IRS was:
Does a business that facilitates the leasing of property between a lessor and lessee constitute a business providing “brokerage services” under Section 1202?
The taxpayer, an online marketplace similar to Airbnb or Zillow, in question facilitates the leasing of property through their website allowing lessors and lessees to enter in non-binding transactions for the use of certain facilities at specified rental rates. The taxpayer charges lessors who are listed in their database a recurring fee along with a percentage of rent paid by the lessee.
The taxpayer claimed that they do not act as a broker in respect to the leasing of the facilities as they provide additional services to the lessors such as website building and hosting.
The IRS concluded
The phrase “brokerage services” is not defined within Section 1202. For the IRS to reach their conclusion, they consulted several additional codes, specifically, IRC Sections 199A, 448 and 6045 to define “brokerage services” in context to Section 1202.
The IRS determined the taxpayer is accurately classified as a broker providing “brokerage services” as the term is defined under Section 6045 and the common dictionary meaning of the term “broker.” In drawing their conclusion, the IRS observed that:
- The taxpayer did not simply publish advertisements to their website. In fact, the website was devoted to establishing non-binding agreements between potential lessors and lessees.
- The taxpayer received a commission whenever a lessor and lessee entered a transaction from using the website.
- The taxpayer lacked the authority to enter into a leasing agreement on behalf of the lessor.
The bottom line
With the release of CCA 202204007, while not in favor of the taxpayer, the IRS provided clarity on the rules as it relates to excluding capital gain on the sale of a QSBS. While the ruling above is specific to this taxpayer, Aprio’s Transaction Advisory Team can help you navigate the complexities to determine whether your business is eligible to receive the QSBS tax incentives under IRC Section 1202.
To determine your business’s eligibility, schedule a consultation with Aprio’s Transaction Advisory team.
About the Author
Cardell is a partner in the Transaction Advisory Services group at Aprio. Cardell has over 15 years of tax consulting experience serving clients across a wide range of industries, including construction, distribution, financial services, manufacturing and telecommunications. Cardell focuses on advising financial and strategic clients on the tax aspects and structuring of taxable and tax-free transactions. These include mergers and acquisitions, dispositions, restructurings, leveraged buy-outs and recapitalizations.