Built-In Gains Tax for S-Corps: How IRC 1374 Applies When Converting from C-Corp

By Yarik Yarosh, CPA ·September 5, 2026 ·8 min read

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

When a C-Corporation converts to an S-Corporation, the IRS does not simply forget about the appreciation that accrued while the entity was a C-Corp. Under IRC 1374, any net recognized built-in gain during the 5-year recognition period triggers a corporate-level tax at the 21% rate, in addition to the shareholder-level pass-through tax. This built-in gains (BIG) tax ensures that C-Corp appreciation doesn’t escape corporate-level taxation simply by converting to S-Corp status before selling assets. The tax applies to the lesser of (1) the net recognized built-in gain for the year, (2) the taxable income of the S-Corp computed as if it were still a C-Corp, or (3) the total net unrealized built-in gain reduced by net recognized built-in gains from prior years within the recognition period. After the 5-year recognition period expires, the BIG tax no longer applies and all gains are taxed only at the shareholder level, making the timing of the conversion and asset sales a critical planning decision.

✓Key takeaway

Built-in gains tax mechanics:

Element	Rule
Tax rate	21% (current corporate rate)
Recognition period	5 years from the first day of the first S-Corp tax year
Applies to	C-Corps that elect S status (and S-Corps that receive assets from C-Corps in tax-free transactions)
Tax base	Lesser of: net recognized built-in gain, taxable income (as if C-Corp), or remaining net unrealized built-in gain
In addition to	Shareholder-level tax on pass-through income
After 5 years	BIG tax no longer applies; gains taxed only at shareholder level

What creates built-in gain:

Asset	Built-In Gain =
Equipment	FMV on conversion date minus adjusted basis on conversion date
Real estate	Same
Inventory	Same
Accounts receivable (accrual method)	Already in income; generally no BIG
Accounts receivable (cash method)	FMV (face value) minus basis ($0) = full amount
Goodwill / intangibles	FMV minus basis (often $0 for self-created goodwill)
Investments	FMV minus basis

How does the BIG tax work and how do you plan around it?

Hypothetical example

Round numbers. For current guidance, see IRS S corporation guidance. A C-Corp with $2,000,000 in total asset FMV and $800,000 in total adjusted basis elects S-Corp status on January 1, 2025.

Built-in gain at conversion:

Asset	FMV at Conversion	Adjusted Basis	Built-In Gain
Equipment	$300,000	$100,000	$200,000
Real estate	$800,000	$400,000	$400,000
Goodwill	$600,000	$0	$600,000
Inventory	$200,000	$200,000	$0
Cash	$100,000	$100,000	$0
Total	$2,000,000	$800,000	$1,200,000

Net unrealized built-in gain (NUBIG) at conversion: $1,200,000.

Year 2 (2026): The S-Corp sells the equipment for $350,000

Item	Amount
Sale price	$350,000
Adjusted basis at sale (after depreciation)	$80,000
Total gain on sale	$270,000
Built-in gain at conversion (equipment)	$200,000
Post-conversion appreciation	$70,000
BIG tax (21% of $200,000)	$42,000
Shareholder tax on full $270,000 (passed through)	Varies by rate

The $42,000 BIG tax is a corporate-level tax paid by the S-Corp itself. The shareholders still pay tax on the full $270,000 gain through their individual returns, but they get a deduction (or adjustment) for the BIG tax paid.

Year 6 (2030): Same sale, but after the 5-year period

Item	Amount
BIG tax	$0 (recognition period expired)
Shareholder tax on gain	Same as above
Tax savings from waiting	$42,000

BIG tax calculation limits:

Limit	How It Works
Taxable income limit	BIG tax cannot exceed what the corporation would have owed if it were still a C-Corp
NUBIG limit	Total BIG tax over the 5-year period is limited to the original NUBIG ($1,200,000 in this example)
NOL offset	C-Corp NOL carryforwards can offset recognized built-in gains
Business credit carryforwards	C-Corp general business credits can offset BIG tax
Capital loss carryforwards	C-Corp capital loss carryforwards can offset built-in capital gains

Example with NOL offset:

Item	Amount
Recognized built-in gain (equipment sale)	$200,000
C-Corp NOL carryforward available	($150,000)
Net built-in gain subject to BIG tax	$50,000
BIG tax (21%)	$10,500
Savings from NOL offset	$31,500

Planning strategies:

Strategy	How It Helps
Wait 5 years to sell appreciated assets	Avoids BIG tax entirely
Accelerate deductions in the first 5 years	Reduce taxable income limit (which caps BIG tax)
Use C-Corp NOL carryforwards	Dollar-for-dollar offset against recognized built-in gains
Get a professional appraisal at conversion	Documents the FMV on the conversion date (IRS will challenge estimates)
Sell assets with no built-in gain first	Inventory at cost, assets with basis equal to FMV, don’t trigger BIG
Installment sale spanning the recognition period	Recognized built-in gain is allocated pro rata to each installment payment
Contribute new capital after conversion	New assets have no built-in gain; appreciation on new assets isn’t subject to BIG

Appraisal at conversion (critical):

Without Appraisal	With Appraisal
IRS may argue higher FMV (larger built-in gain)	Documented FMV at conversion date
Burden of proof on taxpayer	Professional valuation supports taxpayer’s position
Disputes over goodwill valuation	Independent valuation of goodwill and intangibles
No clear allocation among assets	Asset-by-asset FMV documented

When the BIG tax does NOT apply:

Situation	Why
Corporation was always an S-Corp	No C-Corp history; no built-in gains
Asset was acquired after the S-Corp election	Post-conversion assets have no built-in gain
Recognition period (5 years) has passed	BIG tax expires
Asset has a built-in loss at conversion	Built-in losses offset built-in gains (net basis)
S-Corp was formed as an S-Corp from inception	No C-Corp conversion

Interaction with other taxes:

Tax	How It Interacts
Shareholder pass-through tax	Shareholders pay tax on the full gain; the BIG tax reduces the gain passed through (pro rata share of BIG tax is an adjustment)
Section 1231 gains	BIG tax applies to built-in Section 1231 gains within the recognition period
Depreciation recapture	Built-in depreciation recapture is subject to BIG tax
Section 1250 (real estate)	25% unrecaptured Section 1250 gain applies at shareholder level; BIG tax is at 21% corporate rate
NIIT (3.8%)	Applies at shareholder level on the pass-through gain, in addition to the BIG tax

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

Can I spread the gain from a business sale over multiple years?

If the buyer pays in installments, you can report the gain proportionally under IRC 453 as you receive each payment. The installment method applies automatically to any sale where at least one payment is received after the tax year of the sale. Each payment consists of three components: return of basis (tax-free), gain (taxed at capital gains rates), and interest income (taxed as ordinary income). Dealer dispositions, sales of inventory, and sales of depreciable property to a related party don’t qualify for installment treatment. If you elect out of the installment method (by reporting the full gain in the year of sale), you cannot reverse that election without IRS consent.

What is a single-member LLC and how is it taxed?

A single-member LLC is a legal entity with one owner. The IRS treats it as a disregarded entity by default, meaning it does not file its own return; income and expenses flow directly to Schedule C on the owner’s personal Form 1040. The LLC provides liability protection without adding a separate tax return. Self-employment tax applies to all net income, same as a sole proprietorship. You can elect S-Corp taxation by filing Form 2553, which keeps the LLC legal structure while changing the tax treatment to require a reasonable salary and allowing the remaining profit as a distribution free of FICA. State treatment varies: some states charge an annual LLC fee or franchise tax regardless of federal tax election.

Related guides:

Converting C-Corp to S-Corp: Tax Implications and Built-In Gains

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Cite this page

Yarik Yarosh, CPA. "Built-In Gains Tax for S-Corps: How IRC 1374 Applies When Converting from C-Corp." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-built-in-gains-tax-s-corp-irc-1374-conversion

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