Tax
LLC to C-Corp for QSBS: The Conversion-Day Valuation Decides What You Can Exclude
Converting an LLC to a C-corp for QSBS? The fair market value on conversion day sets your $75M ceiling, your 10x exclusion cap, and your holding period.
By 409.AI Team - 2026-09-10
# LLC to C-Corp for QSBS: The Conversion-Day Valuation Decides What You Can Exclude
Plenty of companies start as an LLC for good reasons. Pass-through taxation, flexible profit splits, no second layer of tax on distributions. Then someone runs the numbers on Section 1202, and the conversation changes, because qualified small business stock can wipe out the federal tax on a sale and only a C corporation can issue it.
So the LLC converts. On the day it does, a number most founders have never had measured sets three separate limits on the tax break they just reorganized to capture: what the business is worth that morning.
That number isn't on your balance sheet. It isn't your last SAFE cap either. It's the fair market value of everything the LLC hands to the new corporation, self-built software and goodwill included. Miss it in one direction and the stock isn't QSBS at all. Miss it in the other and you leave tens of millions of exclusion behind.
Why fair value shows up at all
Section 1202 was drafted around companies that were corporations from day one. For those, the size test runs on tax basis, which is forgiving. A company that raised $60 million and spent most of it on salaries can sit comfortably under the ceiling.
Converted LLCs get measured on a different scale. [Section 1202(d)(2)(B)](https://www.law.cornell.edu/uscode/text/26/1202) says the adjusted basis of property contributed to the corporation is determined as if that basis equaled the property's fair market value at the time of contribution. A parallel rule in [Section 1202(i)(1)(B)](https://www.law.cornell.edu/uscode/text/26/1202) says the basis of stock received in exchange for property is, for Section 1202 purposes, never less than the fair market value of what was exchanged.
Two sentences of statute, three consequences.
Consequence one: the $75 million ceiling you can trip without noticing
A corporation can only issue QSBS if its aggregate gross assets stay at or below $75 million at all times before the issuance and immediately after it. That threshold moved up from $50 million for stock issued after July 4, 2025, one of several changes we covered in our breakdown of [what the One Big Beautiful Bill Act did to Section 1202](https://409.ai/articles/qsbs-one-big-beautiful-bill-act-section-1202-changes). The per-issuer dollar cap that moved alongside it starts adjusting for inflation, which is [its own moving target from 2027 onward](https://409.ai/articles/qsbs-75-million-ceiling-inflation-indexing-2027).
For a converting LLC, that $75 million is measured against the fair value of the contributed assets, not their book carrying amounts. [RSM's analysis of the gross assets test](https://rsmus.com/insights/services/business-tax/qsbs-section-gross-assets-test-what-company-true-value.html) makes the practical point bluntly: the measurement sweeps in off-balance-sheet, self-created intangibles such as goodwill, so a company can fail the test even when the tax basis of its assets is close to zero.
Picture a bootstrapped LLC four years in. Cash and equipment on the books total $3 million. Revenue is $14 million and growing 60% a year, and a strategic buyer would pay somewhere near $80 million. Convert, and the corporation is treated as receiving $80 million of assets. The stock issued that day isn't partially qualified or qualified up to a limit. It simply isn't QSBS, and no amount of holding it for five years changes that.
The companies most exposed here are the profitable, capital-efficient ones. They never raised much, so their basis is small and their instinct is that they're nowhere near a $75 million test. Value is what's tested, and value is exactly what they've been building.
Consequence two: the 10x cap runs off conversion-day value
The exclusion is capped per issuer at the greater of two amounts: a dollar limit, now $15 million for stock issued after July 4, 2025, or ten times the aggregate adjusted basis of the QSBS you dispose of that year. For most founders holding cheap founder stock, the dollar limit is the one that binds, because ten times almost nothing is still almost nothing.
Converting an LLC changes that math, and in the founder's favor. Because Section 1202(i)(1)(B) deems your stock basis to be the fair value of what you contributed, the 10x multiplier runs off real value rather than the few thousand dollars you actually put in.
Run the numbers. Say the LLC is worth $30 million at conversion and you hold 25% of it. Your deemed basis for Section 1202 is $7.5 million. Ten times that is $75 million, and $75 million is far greater than the $15 million dollar limit, so $75 million becomes your cap. If instead you'd converted eighteen months earlier when the business was worth $4 million, your deemed basis would have been $1 million, ten times that is $10 million, and you'd fall back to the $15 million dollar limit.
Same company, same founder, same eventual exit. A five-fold difference in how much gain the exclusion can reach, decided by the calendar and by whether anyone measured the value on the way through.
Consequence three: appreciation earned as an LLC never qualifies
The same FMV rule that raises your cap also fences off part of your gain. Holland & Knight's [analysis of partnership and LLC conversions](https://www.hklaw.com/en/insights/publications/2025/08/conversion-of-partnership-and-llc-interests-into-qualified) puts it plainly: because basis is treated as fair value at contribution, only appreciation occurring after the contribution is eligible for exclusion. The built-in gain you created during the LLC years stays taxable.
Continue the example. Your outside basis in the LLC interest was $500,000, so your actual stock basis carries over at $500,000. Six years after converting, your shares sell for $100 million.
Your economic gain is $99.5 million. Eligible gain for Section 1202 purposes is $92.5 million, because the statute treats your basis as the $7.5 million of value you contributed. The $7 million difference between your real basis and your deemed basis is the appreciation you earned as an LLC, and it stays taxable as capital gain no matter how long you hold the stock. Of the $92.5 million that is eligible, the 10x cap lets you exclude $75 million. The remaining $17.5 million is taxable too.
Excluding $75 million of a $99.5 million gain is an excellent outcome. It's also not the "100% tax-free exit" that gets repeated in founder Slack channels, and the gap between those two descriptions is worth understanding before you plan around it.
The clock starts on conversion day, not founding day
Years spent as an LLC earn no credit toward the Section 1202 holding period. Section 1202 requires stock acquired at original issuance from a C corporation, and there's no stock to hold until the conversion creates it. Whether you use a statutory conversion, a check-the-box election, or one of the incorporation patterns described in Rev. Rul. 84-111, the practical result is the same: the clock starts on the conversion date.
For stock issued after July 4, 2025, the payoff arrives in stages. Hold more than three years and 50% of eligible gain is excluded. Four years gets you 75%. Five years gets you the full 100%. A company that operated as an LLC since 2021, converted in September 2026, and sold in early 2030 lands at three and a half years, so half the eligible gain is excluded and half is taxed. The five years of LLC history count for nothing.
If an exit arrives before the clock matures, [Section 1045 lets you roll the proceeds into replacement QSBS](https://409.ai/articles/section-1045-qsbs-rollover-defer-gain-early-sale) and carry your holding period forward, which is the main reason not to treat an early sale as a total loss of the benefit.
Two other tests still apply regardless of how clean the conversion is. The business has to be a qualified trade or business, and the [consulting and services exclusions disqualify more startups than founders expect](https://409.ai/articles/qsbs-qualified-trade-or-business-consulting-test-section-1202). And a federal exclusion isn't a state exclusion, since [several states decline to follow Section 1202](https://409.ai/articles/qsbs-state-tax-conformity-california-new-jersey).
Getting the number defensibly
All three consequences depend on one appraisal performed at a single moment, and that appraisal gets read years later by a buyer's tax counsel, an auditor, or the IRS, at the point where the amount at stake is largest and your contemporaneous evidence is coldest.
A conversion valuation borrows most of its machinery from a 409A. Income and market approaches, a defensible set of comparable companies, documented forecasts. What's being measured differs though. A 409A prices a minority interest in common stock and applies [a discount for lack of marketability](https://409.ai/articles/discount-lack-marketability-dlom-409a-valuation) to reach a strike price. The Section 1202 tests look at the assets going into the corporation, which is a different subject even when the underlying analysis overlaps.
Two housekeeping items decide whether the file holds up. Date the analysis to the conversion, not to whenever someone remembered to commission it. And identify the intangibles specifically, because the goodwill and technology that never touched the balance sheet are the assets driving the gross assets number. If the LLC granted [profits interests to its team](https://409.ai/articles/profits-interests-llc-equity-hurdle-valuation), how those convert into stock affects who is holding QSBS afterward and needs to be settled at the same time.
409.ai prepares [business valuations](https://409.ai/products/smb-valuation) for exactly this kind of transaction, along with [QSBS attestation letters](https://409.ai/products/qsbs) documenting Section 1202 eligibility. Every report is drafted with AI and reviewed and certified by a valuation expert, which is what makes it defensible at the point someone challenges it.
The window, not the deadline
The useful reframing is that an LLC considering C-corp conversion has a value window rather than a conversion deadline. The company-level ceiling is fixed: above $75 million of contributed value, the door closes entirely. The floor is personal to each holder, because the 10x cap runs off your own share of that value. Until your slice of the contributed assets is worth about $1.5 million, ten times basis doesn't beat the $15 million dollar limit, so converting buys holding-period time without buying cap. In between, every extra dollar of value at conversion adds ten dollars of exclusion capacity while moving one dollar of gain out of the excludable column.
Most companies pass through that window once, usually while they're busy with something else. The move is to price the business before you file the conversion paperwork, not after, and to decide the date with that number in front of you.
Sources: [26 U.S. Code § 1202](https://www.law.cornell.edu/uscode/text/26/1202), [Grant Thornton on the enhanced Section 1202 benefits](https://www.grantthornton.com/insights/alerts/tax/2025/insights/explaining-enhanced-section-1202-benefits), [RSM on the gross assets test](https://rsmus.com/insights/services/business-tax/qsbs-section-gross-assets-test-what-company-true-value.html), [Holland & Knight on partnership and LLC conversions](https://www.hklaw.com/en/insights/publications/2025/08/conversion-of-partnership-and-llc-interests-into-qualified). This article is general information, not tax advice for your situation.