The following steps end up working for me after opening a case with Microsoft.....
- Dism /Online /Cleanup-Image /RestoreHealth /Source:\W.X.Y.Z\C$\windows /LimitAccess - (W.X.Y.Z = IP address of a working Windows VM with no issues) to replace any corrupt windows files from a valid source.
- Delete the folder C:$WINDOWS.~BT if it is present.
- Open msconfig and perform a clean boot by disabling all non-Microsoft services, leaving only VMware services enabled.
- Restart the server.
- After the reboot, verify that the third-party services remain disabled and stop any SQL-related services again if SQL is installed (no need to change SQL services Startup Type to Disabled).
- Mount the Windows Server 2025 ISO. I actually got the latest Windows Server ISO with the most recent cumulative updates added (June 2026) from my M365 Account.
- Launch the in-place upgrade from an elevated Command Prompt using command: setup.exe /auto upgrade /dynamicupdate disable /compat ignorewarning
Install completed normally and all of the Windows Updates were already installed.