Breaking down the OBBBA: why Section 1202 just became private equity’s new tax efficiency power move

When the One Big Beautiful Bill Act (OBBBA) became law on July 4, 2025, most headlines zeroed in on its extensions to the Tax Cuts and Jobs Act. But tucked inside the bill is one of the most strategic tax advantages investors and private equity (PE) firms have seen in years. The update to Section 1202, which governs Qualified Small Business Stock (QSBS), just shifted from a niche startup perk to a potentially powerful PE strategy.

Here is what changed, why it matters and how it could reshape deal modeling.

The short version

The OBBBA expands Section 1202 by:

1. Introducing a graduated holding period that unlocks partial gain exclusion earlier 
2. Increasing the company asset size limit so more portfolio companies qualify
3. Raising the maximum gain exclusion and tying it to inflation

Why this matters: more eligible deals, shorter time horizons and bigger tax savings. Let’s break this down further.

Section 1202 at a glance: key changes under the OBBBA

Graduated holding period: no more five-year all-or-nothing rule

The old rule: investors had to hold QSBS for five years to qualify for a 100% gain exclusion. If you exited at four years and eleven months, you got nothing. 

The new rule:

• 3-year holding: 50% gain exclusion
• 4-year holding: 75% gain exclusion
• 5-year holding: 100% gain exclusion

PE operates on deal timelines, not on calendar-rounding optimism. Shorter horizons mean flexibility. Flexibility means strategy. Strategy means better returns.

Example:

A fund invests $10 million in a qualifying C-corporation. Three years later, it exits for $25 million. Gain: $15 million.

• Before OBBBA: zero exclusion, even at year four.
• After OBBBA: 50% of that gain, or $7.5 million, is excluded.

At a 24% effective tax rate, that’s roughly $1.2 million in tax savings. Same deal. Same work. Better outcome.

* 20% plus 3.8% NIIT

** Unexcluded gain taxed at a 28% rate, plus 3.8% NIIT

Higher asset threshold: more companies now qualify for QSBS

The old rule: The asset limit threshold for a company to issue QSBS was $50 million, with no adjustment for inflation.

The new rule: The asset limit increases to $75 million, with inflation indexing starting in 2027.

For PE, this is a green light. Growth-stage companies, the lower-middle market and businesses on the brink of scaling have significantly more headroom to issue QSBS. More eligible deals. Less diligence anxiety. Better upside potential.

Higher gain exclusions: bigger benefits that grow with inflation

The old rule: This exclusion was limited to the greater of $10 million or 10 times the adjusted basis in the QSBS.

The new rule: The exclusion increases to $15 million or 10 times the adjusted basis in the QSBS, whichever is greater, and begins indexing for inflation in 2027. A higher exclusion gives PE firms more runway on exits and better modeling predictability. They can now map expected tax savings across portfolio investments without guessing whether future inflation will eat into the upside.

Bottom line: Section 1202 just got PE-friendly

Section 1202 was always powerful but rarely practical for PE. The holding period was too long, the company size limit was too tight and the gain cap was restrictive.

Now, thanks to the OBBBA:

• PE firms can use C-corporation structures more confidently
• Partial exclusion can be unlocked as early as year three
• More growth stage companies qualify as QSBS

This is no longer a theoretical planning tool. It is a real tax efficiency lever.

The catch: QSBS rules are technical. Entity structuring, timing, asset tests and exit strategy must align from day one. Miss a requirement and the benefit disappears.

What’s next?

Can this work with our current fund model? Should we be evaluating upcoming deals through a QSBS lens? The answers are likely yes.

More upside. Less tax drag. Faster access to gain exclusions. That is the kind of efficiency you do not leave on the table. The Sikich Transaction Advisory Services team is ready to help evaluate deal structures, model the tax impact and assess which opportunities are 1202-eligible.

This article is part of our continued analysis of the OBBBA. Visit the OBBBA hub for all of our coverage.

About our authors

Sharif Ford, CPA, MBA, specializes in the tax aspects of mergers and acquisitions and other strategic transactions. His expertise includes analyzing tax due diligence matters, tax restructuring opportunities and transaction documents.

Greg Lohmeyer, JD, LLM, also specializes in mergers and acquisitions and other strategic transactions. His background includes leading tax due diligence efforts, identifying and implementing tax structuring opportunities, reviewing tax provisions in transaction documents and leading post-merger integration activities.