1042 Exchanges: Deferring Capital Gains When Selling to an ESOP
1042 Exchanges
A Tax-Advantaged Exit Strategy
Selling your company to an Employee Stock Ownership Plan (ESOP) can be one of the most tax-advantaged exit strategies available. One of the most powerful benefits for sellers is the opportunity to defer—and in some cases eliminate—capital gains tax on the sale through a Section 1042 exchange.
At SSG Companies, we guide business owners across Louisiana, Texas, Arkansas, and nationwide through the 1042 exchange process to help them maximize liquidity and preserve wealth.
What Is a 1042 Exchange?
Section 1042 of the Internal Revenue Code allows owners of closely held C corporations who sell at least 30% of company stock to an ESOP to defer capital gains tax on the sale. This is done by reinvesting the proceeds in qualified replacement property (QRP), such as stocks and bonds of U.S. operating companies.
Key Benefits of a 1042 Exchange
- Deferral of Capital Gains Tax
Sellers can defer the recognition of capital gains as long as they hold the QRP. - Potential for Permanent Tax Elimination
If the seller holds the QRP until death, the assets receive a step-up in basis—potentially eliminating the deferred gain altogether. - Enhanced After-Tax Proceeds
Deferring or avoiding capital gains tax can significantly increase the net amount available for retirement, reinvestment, or estate planning.
Who Qualifies?
- The company must be structured as a C corporation at the time of sale
- The ESOP must purchase at least 30% of the company’s outstanding stock
- The seller must reinvest the proceeds into qualified replacement property within 12 months of the sale.
What Counts as Qualified Replacement Property (QRP)?
QRP generally includes stocks, bonds, or debt obligations of U.S. operating companies. Investments in mutual funds, partnerships, or foreign companies do not qualify.
We help sellers evaluate QRP options that align with their risk tolerance, liquidity needs, and overall estate plan.
Our 1042 Exchange Services
We guide clients through every step of the process:
Feasibility Analysis
Determining whether your company and transaction meet the 1042 requirements.
QRP Selection
Helping you identify and acquire qualified replacement property within the required timeframe.
Transaction Structuring
Coordinating with your legal and tax advisors to design the sale for maximum tax efficiency.
Integration With Estate Planning
Aligning the 1042 exchange with broader wealth transfer and charitable planning strategies.
Why Early Planning is Critical
The 1042 election must be made within strict timelines, and missing a step can result in losing the tax benefit. Early coordination with advisors is essential.
Learn More
Funding ESOP Repurchase Liabilities »
See how to manage the company’s long-term obligations
ESOP Consulting Services »
Explore our broader ESOP design and administration support
Ready to Explore a 1042 Exchange?
We’ve helped business owners across the Gulf South use 1042 exchanges to unlock more value from their ESOP sales. Let’s discuss whether it makes sense for you.