List of Qualified Replacement Property Stocks

There is no IRS-published list of qualified replacement property stocks. Section 1042 works by criteria, not by roster: any security issued by a U.S. domestic operating corporation that meets an active-business test and a passive-income ceiling can serve as qualified replacement property (QRP). In practice, that opens the door to thousands of publicly traded U.S. company shares, corporate bonds from the same universe of issuers, and specially structured floating rate notes designed for ESOP sellers.

Securities That Qualify

Section 1042(c)(4) borrows the word “security” from Section 165(g)(2), which sweeps in a broad range of instruments. The categories that qualify as QRP include:

Common stock of U.S. operating companies, including shares listed on the NYSE or Nasdaq.
Preferred stock with voting or dividend rights, provided the issuer qualifies.
Corporate bonds issued by a qualifying domestic corporation.
Convertible bonds exchangeable for stock in the same qualifying issuer.
Floating rate notes structured specifically as QRP-compliant instruments.

Because eligibility runs off criteria rather than a list, a seller can build a portfolio of blue-chip operating company shares, a single large corporate bond, or any mix. Each issuer just needs to pass the operating-corporation tests on its own.

What Does Not Qualify

Section 1042(c)(4)(D) explicitly removes federal, state, and municipal obligations from the definition of “security” for QRP purposes.¹ Treasury bonds, municipal bonds, and agency debt all fail.

Several other common holdings fall outside the definition because they are not securities of a domestic operating corporation:

Mutual funds and ETFs. Shares in a pooled vehicle represent ownership in the fund, not a direct security of the underlying operating companies.
Real estate. Physical property is not a security.
Foreign stocks and bonds. The issuer must be a U.S. corporation.
Stock of the selling company, or of any member of its controlled group under Section 1563(a)(1).¹

The controlled-group rule catches an easy-to-miss case: if the selling company has a parent or sister subsidiaries, their securities are also off-limits.

Two Tests the Issuing Company Must Pass

Not every U.S. corporation counts as a domestic operating corporation. The statute imposes two specific tests, and both must be satisfied by the issuer of any security you buy as QRP.

Active-Business Asset Test

More than 50% of the corporation’s assets must be used in the active conduct of a trade or business at the time you purchase the security, or before the replacement period closes.¹ This knocks out shell companies, investment holding companies, and entities that mainly hold undeveloped land or passive assets. Banks described in Section 581 and insurance companies taxed under Subchapter L automatically qualify as operating corporations even though their balance sheets carry heavy financial assets.

25% Passive-Income Ceiling

The issuer cannot have derived more than 25% of its gross receipts from passive investment income during the tax year before you purchased the security.¹ Passive investment income here means royalties, rents, dividends, interest, and annuities, using the definition in Section 1362(d)(3)(C).² A company that earns most of its revenue from operations and collects some investment income on the side will usually pass. A company built around a portfolio generating dividend and interest income will not.

Most large publicly traded operating companies — manufacturers, tech firms, retailers, healthcare businesses — clear both tests without difficulty. The risk lives with smaller or less conventional issuers, so before treating anything unusual as QRP, confirm from the issuer’s financial statements that passive receipts stayed under 25% in the prior tax year.

How Sellers Actually Build a QRP Portfolio

Two approaches dominate. Each has real trade-offs tied to liquidity, risk tolerance, and holding period.

Diversified Stock and Bond Portfolio

You can buy shares of individual publicly traded U.S. operating companies and hold them as QRP, alongside qualifying corporate bonds. The portfolio can be shaped around your investment goals: growth stocks, dividend-paying blue chips, corporate bonds, or a mix. Dividends and interest keep flowing while the deferral remains intact. The trade-off is concentration risk if you own only a few names, and the fact that you cannot freely trade in and out of positions without triggering recapture on whatever you sell.

Floating Rate Notes

Floating rate notes are corporate bonds with variable interest rates, often structured specifically for Section 1042 transactions. Their appeal is leverage. Because FRNs are marginable, banks will typically lend up to 90% of the note’s face value, letting a seller purchase QRP equal to 100% of the taxable gain with a relatively small cash outlay. That matters when the ESOP transaction pays only about 25% of the sale price in cash at closing, with the rest arriving over time through a seller note.

The catch is that the margin loan becomes a long-term commitment. It requires ongoing interest payments and a personal guarantee, and is rarely paid off during the seller’s lifetime. FRNs also produce less total return than a well-constructed equity portfolio. Sellers who need cash immediately often favor FRNs. Sellers comfortable with a buy-and-hold approach often prefer stocks that can grow over time and pass to heirs with a stepped-up basis.

The Purchase Has to Happen in a 15-Month Window

The replacement period starts three months before the ESOP sale date and ends twelve months after it.¹ The three-month pre-sale window lets a seller who knows a deal is coming start building the portfolio in advance. Miss the twelve-month back end and the deferral is gone; the IRS does not extend this deadline.

The deferral applies only to the extent that the cost of QRP purchased inside the window equals or exceeds the amount realized on the ESOP sale. Sell stock for $5 million but buy only $4 million in QRP, and you recognize gain on the uncovered $1 million.

Why the “Stocks” Choice Locks You In

The deferral under Section 1042 is a postponement, not an elimination, and it lives in the basis of your QRP. When you purchase QRP, its cost basis is reduced by the deferred gain. Sell $5 million in company stock with a $1 million basis, invest the full $5 million in QRP, and the new QRP carries a basis of only $1 million.¹

Section 1042(e) then provides that any later disposition of the QRP triggers gain to the extent of the deferred amount.¹ There is no holding period after which recapture disappears. Selling a portion of your QRP triggers a proportionate share of the deferred gain. That is why picking individual stocks as QRP is closer to a permanent portfolio decision than a normal investment allocation: you cannot rebalance freely without giving back the deferral on what you sell.

The statute also contains a subtler trap. If a corporation that issued your QRP disposes of a substantial portion of its assets outside the ordinary course of business, and you own stock representing control of that corporation, you are treated as having disposed of the QRP yourself.

Events That Do Not Trigger Recapture

Death. The QRP receives a stepped-up basis at the death of the person who made the Section 1042 election, and the deferred gain is never recognized.
Gifts. Transferring QRP by gift does not trigger recapture, but the recipient takes your carryover basis and inherits the deferred gain exposure.
Certain tax-free reorganizations under Section 368, provided the seller does not control the acquiring or acquired corporation while holding substituted-basis property.
A disposition that itself qualifies for a new Section 1042 deferral.

The death exception is why QRP is often treated as a hold-forever strategy. A seller who never disposes of the QRP during their lifetime eliminates the deferred capital gains tax entirely through the basis step-up at death, which shapes how many sellers pick between a growth-oriented stock portfolio and a leveraged FRN structure in the first place.

1
Office of the Law Revision Counsel. 26 U.S. Code 1042 – Sales of Stock to Employee Stock Ownership Plans or Certain Cooperatives
2
Office of the Law Revision Counsel. 26 U.S. Code 1362 – Election; Revocation; Termination