A calendar-year C corporation converts to S corporation status effective January 1, 2025. It held an appreciated asset with built-in gain as of that date and sells the asset in 2028 for a further gain. Under IRC Section 1374, is the corporation subject to the built-in gains tax on the portion of gain that existed as of the conversion date?
- No, because the built-in gains tax was permanently repealed for all S corporations by the Tax Cuts and Jobs Act
- Yes, but only if the corporation sells the asset within one year of the S election, since the recognition period is limited to a single tax year
- Yes, because 2028 falls within the five-year recognition period that began January 1, 2025, the first day of the corporation's first tax year as an S corporation
- No, because the recognition period is ten years, and 2028 falls outside that ten-year window measured from the conversion date
Why C? And why not the others?
Correct answer: C. Yes, because 2028 falls within the five-year recognition period that began January 1, 2025, the first day of the corporation's first tax year as an S corporation
The recognition period for the built-in gains tax under IRC Section 1374 is the five-year period beginning with the first day of the corporation's first tax year as an S corporation, which here runs from January 1, 2025 through the end of 2029; a sale in 2028 of an asset holding gain that had built up before the conversion falls squarely within that window and triggers the built-in gains tax, computed at the highest corporate rate under Section 11(b), on the recognized built-in gain. The option claiming outright repeal is wrong because the built-in gains tax remains part of current law; only the length of its recognition period has changed over time. The option describing a one-year window invents a recognition period that has never applied under any version of Section 1374. The option describing a ten-year window states the recognition period that applied before the PATH Act permanently shortened it to five years for tax years beginning on or after January 1, 2015, well before this corporation's 2025 conversion.
Source: IRC Section 1374(d)(7), as amended by the Protecting Americans from Tax Hikes (PATH) Act of 2015