Built-In Gains Tax (IRC 1374): Converting from C-Corp to S-Corp Without the Tax Trap

By Yarik Yarosh, CPA ·September 5, 2026 ·7 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

When a C-Corporation elects S-Corporation status, it does not get a fresh start on unrealized gains. IRC 1374 imposes a corporate-level tax (the built-in gains tax, or BIG tax) on any net recognized built-in gain if the former C-Corp disposes of assets within the recognition period (5 years after the S election effective date). The BIG tax rate is the highest corporate rate (currently 21%), and the gain is also taxed to the shareholders when distributed, creating a partial double tax that mirrors the C-Corp structure the business was trying to leave behind. The BIG tax applies only to gain that existed at the conversion date (measured by comparing each asset’s fair market value on the conversion date to its adjusted basis). Appreciation that occurs entirely after the S election is not subject to BIG tax, even if the asset is sold within the recognition period. Once the 5-year recognition period expires, all assets can be sold free of BIG tax. This means timing the conversion relative to planned asset sales is critical.

✓Key takeaway

Built-in gains tax framework:

Element	Details
Applies to	C-Corps that convert to S-Corp status (and S-Corps that receive C-Corp assets in tax-free transactions)
Tax rate	21% (highest corporate rate) at the entity level
Recognition period	5 years from the effective date of the S election
What is taxed	Net recognized built-in gain (gain that existed at conversion date)
What is NOT taxed	Post-conversion appreciation (gain accruing after S election)
Additional tax	Shareholders also pay tax on distributions (potentially 23.8% LTCG), creating partial double taxation
After recognition period	No BIG tax on any asset sales, regardless of when gain accrued

Net unrealized built-in gain (NUBIG) calculation at conversion:

Item	Calculation
FMV of all assets on conversion date	Sum of all asset FMVs
Minus: Adjusted basis of all assets	Sum of all tax bases
Equals: Net unrealized built-in gain	Cap on total BIG tax exposure

Key limitations:

Limitation	Effect
NUBIG cap	Total BIG tax cannot exceed the NUBIG determined at conversion
Taxable income limitation	BIG tax is limited to the S-Corp’s taxable income for the year (computed as if it were a C-Corp)
NOL carryforward	C-Corp NOLs carried into the S-Corp can offset BIG tax
Business credit carryforward	C-Corp general business credits can offset BIG tax

How does the BIG tax work on a real conversion?

Hypothetical example

Round numbers. A C-Corp converts to S-Corp effective January 1, 2025. The corporation has two owners (50/50) and the following assets:

Asset values at conversion date:

Asset	Adjusted Basis	FMV at Conversion	Built-In Gain
Equipment	$50,000	$80,000	$30,000
Real estate	$200,000	$500,000	$300,000
Accounts receivable (cash-basis)	$0	$100,000	$100,000
Inventory	$75,000	$90,000	$15,000
Goodwill	$0	$400,000	$400,000
Total	$325,000	$1,170,000	$845,000 (NUBIG)

Scenario 1: Sell real estate in Year 2 (within recognition period)

Item	Amount
Sale price (Year 2)	$550,000
Adjusted basis	$200,000
Total gain	$350,000
Built-in gain at conversion	$300,000 (FMV at conversion minus basis)
Post-conversion appreciation	$50,000 ($550K sale minus $500K conversion FMV)
BIG tax (21% on $300,000)	$63,000
Shareholder-level tax on $287,000 distribution ($350K gain - $63K BIG tax, split 50/50)	$68,306 (23.8% x $287,000)
Total tax	$131,306
Effective rate on $350,000 gain	37.5%

Compare to pure S-Corp (no BIG tax):

Item	Amount
Total gain	$350,000
Tax at shareholder level (23.8%)	$83,300
Tax savings from waiting past recognition period	$47,900 (avoided BIG tax minus the extra shareholder tax on the $63K)

Scenario 2: Sell real estate in Year 6 (after recognition period)

Item	Amount
Sale price (Year 6)	$550,000
Adjusted basis	$200,000
Total gain	$350,000
BIG tax	$0 (past 5-year recognition period)
Shareholder-level tax (23.8%)	$83,300
Total tax	$83,300
Effective rate	23.8%

Scenario 3: Collect accounts receivable in Year 1 Cash-basis C-Corps that convert to S-Corp have a built-in gain in their receivables (basis = $0, FMV = face value):

Item	Amount
A/R collected in Year 1	$100,000
Built-in gain (cash basis, $0 basis)	$100,000
BIG tax (21%)	$21,000
Shareholder tax on $79,000	$18,802
Total tax on A/R	$39,802
Effective rate	39.8%

This is the cash-basis receivable trap: converting a cash-basis C-Corp to S-Corp triggers BIG tax on all outstanding receivables when collected.

Planning strategies:

Strategy	How It Works	Tax Savings
Wait out the recognition period	Don’t sell appreciated assets for 5 years	Eliminates BIG tax entirely
Use C-Corp NOL carryforwards	C-Corp NOLs offset recognized built-in gains	$1 of NOL saves $0.21 in BIG tax
Accelerate basis before conversion	Bonus depreciation or Section 179 on equipment before converting	Reduces built-in gain in equipment
Collect receivables before converting	Cash-basis C-Corp collects A/R (taxed at C-Corp rate) before S election	Eliminates BIG tax on receivables ($21K saved if $100K A/R)
Appraise assets at conversion	Formal appraisal establishes FMV at conversion date, proving which gains are built-in vs. post-conversion	Protects post-conversion appreciation from BIG tax
Installment sale within recognition period	BIG tax applies only to gain recognized in each year (installment method can spread it)	Manages annual BIG tax and taxable income limitation

The C-Corp NOL offset: If the C-Corp had a $200,000 NOL carryforward at conversion:

Without NOL Offset	With NOL Offset
Recognized BIG: $300,000	Recognized BIG: $300,000
NOL offset: $0	NOL offset: ($200,000)
BIG tax base: $300,000	BIG tax base: $100,000
BIG tax: $63,000	BIG tax: $21,000
Savings from NOL	$42,000

The C-Corp NOL carryforward does NOT become an S-Corp NOL. It can ONLY offset recognized built-in gains during the recognition period, and expires unused after the recognition period ends.

Taxable income limitation: If the S-Corp’s taxable income (computed as if it were a C-Corp) is only $150,000, the BIG tax is limited:

Item	Amount
Recognized built-in gain	$300,000
Taxable income limitation	$150,000
BIG tax (21% x $150,000)	$31,500 (not $63,000)
Excess $150,000 BIG carries forward	Applied in the next year within the recognition period

Illustrative numbers only, not a real client and not advice for your facts.

What is the difference between short-term and long-term capital gains rates?

Assets held for one year or less generate short-term capital gains, taxed at your ordinary income tax rate (up to 37% federal). Assets held for more than one year qualify for long-term capital gains rates of 0%, 15%, or 20%, depending on your taxable income. High-income taxpayers may also owe the 3.8% net investment income tax (NIIT) under IRC 1411 on top of the capital gains rate. The holding period starts the day after you acquire the asset and includes the day you sell it. For business owners planning a sale, timing the disposition to cross the one-year threshold can save 15-20 percentage points in federal tax on the gain.

Related guides:

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Cite this page

Yarik Yarosh, CPA. "Built-In Gains Tax (IRC 1374): Converting from C-Corp to S-Corp Without the Tax Trap." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-built-in-gains-tax-irc-1374-c-to-s-conversion

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.