It is rare for the government and entrepreneurs to have the same mindset with a particular idea. However, the thought that investing in small businesses is a good idea is one concept they can agree on. In order to encourage people to make such an investment, Congress has implemented tax benefits to those who invest in small businesses that meet the definition of a Qualified Small Business, or QSB. There are three specific tax benefits which are a 50% exclusion of gain appreciated by investors when the stock is disposed, a deferral of gains if the investor rolls over the gains to invest in another QSB’s stock, and a re-characterization of capital losses if the investor loses money in the investment.

Section 1045 of the Internal Revenue Code, often known simply as the Code, allows investors to sell QSB stock without gaining anything taxable as long as they reinvest the gains into a new QSB within 60 days of the sale. This is a benefit that investors can appreciate when investing in small businesses as long as the investors are not corporations themselves. Also, the stock needs to have been held onto for six months prior to the sale to utilize this benefit. Any money that is left over when the subsequent stock is purchased after the sale will be taxed.

There is always a risk in investing in small businesses, even despite the tax benefits you appreciate. If the company fails to meet up to their own expectations, you will lose money in your investment. Fortunately, investors may be able to use the losses as ordinary losses instead of capital losses. This will help offset ordinary income. Of course, all of these benefits have exclusions and exceptions. When utilized properly, however, you could benefit greatly as an investor in small businesses, thus helping to offset some of the inherent risk of making such an investment.

In order for entrepreneurs to attract people to invest in their businesses, these benefits are imperative so investors can reduce their level of risk and increase returns. To make sure you are eligible to receive all these tax benefits of investing in small businesses, you should first speak with your tax advisor before investing any money. After all, tax laws are long and confusing, forms change every year, and there are certain things you must do to qualify for the benefits. When it doubt, speak with your tax advisor.