Section 1202(h)(4) states “the basis of such stock in the hands of the taxpayer shall in no event be less than the fair market value of the property exchanged”, meaning that the property exchanged for QSBS is valued at fair market value (FMV) and not historical cost when determining the basis in the QSBS. Therefore, if the property’s FMV is higher on the date of the exchange this would imply that there is a built-in gain carried with the property. The built-in gain happened before the issuance stock, which means it would be taxed separately and would not be excluded under Section 1202. Although the gain is taxed on the exchange, the gain will be included in the basis of the QSBS.

If the stock was exchanged in a tax-free transaction under Section 351 or reorganization under Section 368 then the built-in gains on the stock would not be taxed on the date of the exchange.

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